The Role of Reverse Auctions in Strategic Sourcing

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Stewart Beall CAPS Research Craig Carter, Ph.D. Robert H. Smith School of Business University of Maryland Phillip L. Carter, D.B.A. CAPS Research W.P. Carey School of Business Arizona State University Thomas Germer Graduate School of Management WHU, Otto Beisheim University Thomas Hendrick, Ph.D. W.P. Carey School of Business Arizona State University Sandy Jap, Ph.D. Goizueta Business School Emory University Lutz Kaufmann, Ph.D. Graduate School of Management WHU, Otto Beisheim University Debbie Maciejewski CAPS Research W.P. Carey School of Business Arizona State University Robert Monczka, Ph.D. CAPS Research W.P. Carey School of Business Arizona State University Ken Petersen, Ph.D. W.P. Carey School of Business Arizona State University

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The Role of Reverse Auctions in Strategic Sourcing

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Table of Contents

Executive Summary ...... 7 Defining E-RAs...... 7 Overview of the Study’s Methodology ...... 7 Why E-RAs?...... 7 E-RAs Are Controversial ...... 7 Beneficial Aspects of E-RAs...... 8 Dysfunctional Aspects of E-RAs ...... 9 Benefits to Suppliers ...... 9 Actual vs. Potential Applications of e-RAs ...... 9 E-RA Spend Dollars, Percentages, and Trends ...... 9 Sustainability of the Use and Economic Value Add of E-RAs ...... 10 Non-User Observations and Issues ...... 11 Ethical Issues Related to E-RA Use ...... 12 Conclusions ...... 13

Executive Overview ...... 14

Introduction ...... 22 Defining E-RAs...... 22 Reverse vs. Forward Auctions ...... 22

Objectives of the Study ...... 23 Overview of the Study’s Methodology ...... 23

Why E-RAs? ...... 24 Top Management’s Expectations and Support of E-RA Use...... 25

Benefits/Dysfunctional Aspects of E-RAs ...... 26 Direct Cost Reductions ...... 26 Biddable Attributes ...... 26 E-RAs Can Create Markets ...... 26 Cycle-Time Savings for Buyers and Suppliers ...... 27 Increased Buyers’ Reach ...... 27 Total Cost Analysis ...... 27 Price Visibility ...... 27 Transparency of the Purchasing and Supplying Processes...... 28 Overall Process Efficiency/Productivity ...... 28 Other/Indirect Savings ...... 28 Benefit/Cost Justification ...... 28 Dysfunctional Aspects of E-RAs...... 28

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Benefits to Suppliers ...... 29 Actual vs. Potential Application of E-RAs...... 29

The Strategic Context of E-RAs...... 30 The E-Oriented Strategic Sourcing Process ...... 30 Spend Analysis and Opportunity Assessment ...... 30 Develop E-Sourcing Strategy ...... 32 Identify Potential Suppliers ...... 32 Issue and Evaluate Returned RFxs...... 32 Develop Reverse Auction Strategy ...... 32 Hold the Reverse Auction ...... 33 Award Business If Conditions Are Met...... 33 Follow-Up and Re-Sourcing ...... 34 The Interaction of E-RAs and the Other Components of the Strategic Sourcing Process ...... 34

Spend Dollars, Percentages, and Trends ...... 35 E-RA Event Experience...... 35 Experience across the Global Economy ...... 35 Experience across Industries ...... 37 Experience across Commodity Types...... 37

Sustainability of the Use of E-RAs...... 39 Sustainability of E-RAs As a Tool...... 39 Sustainability of E-RA Results ...... 40 Sustainability of Supplier Performance ...... 40

E-RA Implementation Strategies ...... 42 Implementation of E-RAs in Buyer Organizations ...... 42 Implementation of E-RAs in Supplier Organizations ...... 42 E-RA Training for Buyers and Suppliers...... 43

Planning and Managing the E-RA Event ...... 44 The E-RA Sourcing Decision ...... 44 Preparation for the E-RA Event ...... 44 Observations from Interviews Regarding Preparation ...... 45 Role of Cross-Functional Teams in E-RAs ...... 45 Buyer-Supplier Communication ...... 45 Buyer-Supplier Communication during an E-RA Event ...... 46 Role of RFxs in E-RAs...... 46 Test Runs, Contingency Planning, and Supplier Training ...... 47 Non-Participation Rules ...... 48 Lotting Strategies by Buying Firms ...... 48 Closing Strategies ...... 48 Bid Commitment Duration ...... 49 E-Tool Suite Development...... 49

Successful vs. Unsuccessful E-RA Events...... 50 Defining Success...... 50 Level of Competition ...... 50 Size of the E-RA Event ...... 50 Supplier Visibility ...... 50 Lotting Strategies ...... 51 Item Specificity and Complexity ...... 51 Switching Costs ...... 51 Supplier Success and Change Costs...... 51

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The Auction Experience of Buyers and Suppliers...... 52 Buyer-Supplier Relationships...... 52

Emerging Issues ...... 53 Will Repeat Buys Deliver Value? ...... 53 Will Smaller or Larger Supplier Bases Develop? ...... 53 Do E-RAs Result in a Shift in Power from Suppliers to Buyers? ...... 54 What Effects Will E-RAs Have upon Negotiation Skills?...... 54 What is Happening to the Development of E-RA Functionalities from Providers?...... 54 Are Dynamic E-TCO Tools Available? ...... 54 Will the Importance of E-RFxs Increase? ...... 55 Do Global Obstacles Limit the Use of E-RAs? ...... 55

Non-User Observations and Issues ...... 56 Reasons for Non-Use ...... 56 Conclusions Regarding Non-Users ...... 56

Ethical Issues Related to E-RA Use ...... 57 Observed Ethical Issues ...... 57 Potential vs. Actual Unethical Practices ...... 58 Avoiding Actual or Perceived Unethical Practices ...... 58 Ethical Issues Unique to E-RAs ...... 58

Conclusions...... 60

Case Studies ...... 61 GlaxoSmithKline ...... 61 Bechtel ...... 66 Volkswagen Group ...... 68 METRO Group...... 73

CAPS Research...... 86

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Figures, Tables, and Appendices

Figures Tables

Figure 1: Components of Typical E-Oriented Table 1: CAPS Research Large Company Strategic Sourcing Process ...... 30 Survey ...... 35

Figure 2: Sourcing Strategy Matrix ...... 31 Table 2: Ethical Issues Surrounding Reverse Auctions ...... 57 Figure 3: Companies’ Use of E-RAs ...... 36 Table 3: Items GSK Sources via E-RAs . . . . . 65 Figure 4: Applicability of E-RAs: Switching Costs vs. Length of Current Contract . . . . 37 Table 4: VW Application Transfer Volume. . . 70

Figure 5: GSK Management’s Changing Expectations of E-Ras ...... 62 Appendices

Figure 6: GSK’s Definition of E-Ras ...... 63 A: Methodology ...... 80

Figure 7: GSK’s E-Sourcing Tools ...... 64 B: Auction Typology ...... 82

Figure 8: GSK Sourcing Tool Matrix...... 64 C: Methodology References ...... 85

Figure 9: Bechtel Reverse Auctions...... 67

Figure 10: Bechtel E-RA Process...... 67

Figure 11: VW/Supplier Areas of Collaboration 70

Figure 12: VW Online Auction Positions . . . . . 71

Figure 13: VW Sample Invitation...... 72

Figure 14: E-RA Process at METRO ...... 75

Figure 15: METRO Registration Form + Undertaking ...... 77

Figure 16: Code of Conduct GlobalNetXchange ...... 78

Figure 17: Auction Typology ...... 82

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Executive Summary

In the mid-1990s, a new electronic sourcing tool • Third-party providers of e-RA services (e.g., emerged that has had, and is continuing to have, a eBreviate, FreeMarkets) profound impact on the way in which firms source • A targeted number of firms who had specifically goods and services from current and potential external chosen not to use e-RA tools for sourcing. suppliers. This tool, while known by other names (e.g., “online negotiation”) is the electronic reverse auction (e-RA). The purpose of this study is to present the initial Why E-RAs? results of a comprehensive study of e-RAs undertaken by CAPS Research during 2002. Why the intense interest in e-RAs? The dramatic growth of the use of e-RAs over the past few years has been facilitated both directly and indirectly by a number of Defining E-RAs converging internal and external developments and forces, including: In its basic form, an e-RA is an online, real-time dynamic auction between a buying organization and a group of • Widespread ability for buyers and suppliers to pre-qualified suppliers who compete against each other economically communicate in real time, worldwide, to win the business to supply goods or services that have via the Internet. clearly defined specifications for design, quantity, quality, • Development of robust, user-friendly Internet-based delivery, and related terms and conditions. These software systems to support worldwide e-RA events suppliers compete by bidding against each other online that are either hosted by a third party or designed to over the Internet using specialized software by submitting be run by the buying company with little or no successively lower priced bids during a scheduled time outside assistance. period. This time period is usually only about an hour, • Recent order-of-magnitude improvements in quality but multiple, brief extensions are usually allowed if and cycle-time reductions have resulted in buying bidders are still active at the end of the initial time period. companies perceiving superior quality and service as “givens.” Thus, they have shifted their emphasis toward low price as a major sourcing decision variable. Overview of the Study’s Methodology

The study’s methodology consisted primarily of analyzing E-RAs Are Controversial face-to-face and teleconference-structured interviews performed in the United States and Europe during mid- The birth and acceptance of e-RA tools has not been 2002, with the following organizations: without controversy, because, for some, its process is contradictory to the long-term benefits associated with • A targeted number of firms who were considered to collaborative/cooperative buyer-supplier alliances. This be “power users” of e-RAs for sourcing goods and perceived conflict is primarily caused by the tool’s services from external suppliers emphasis on awarding business based on aggressive • A targeted number of suppliers who had participated price competition (the classical arm’s length coercive/ in e-RA events competitive model) instead of long-term total cost of

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ownership (TCO) considerations. However, this research Biddable Attributes: Not everything a company buys is has concluded that for a growing number of buying e-RA biddable. Especially exempt are items or services firms, e-RAs have found an appropriate niche in their that do not have clearly defined attributes that competing strategic sourcing toolkit, allowing them to efficiently suppliers can translate into unambiguous specifications. source goods and services that are highly standardized, Second are items that are highly differentiated strategic have sufficient spend volume, can be replicated by a items. Third are instances in which switching suppliers reasonable number of qualified competitors, and have would result in unacceptably large change costs. Fourth insignificant switching costs. In contrast, the research are items where the volume or value is so low that the indicates that those suppliers of strategic items, where potential savings do not cover the cost of holding the alliance-level supplier relationships are critical, are event. What then, are the major attributes of a biddable usually not subjected to e-RA sourcing. good or service? In general, they are:

Generally, suppliers asked to participate in e-RAs, 1. Items can be clearly specified (via design, terms, especially incumbent suppliers, do so reluctantly for fear and conditions) and translated into prices a of losing business. Overall, incumbent suppliers win supplier will commit to charge the buyer. about half of the e-RA events in which they participate, 2. There is a strong likelihood that the current with the balance going to contender suppliers, sometimes price is sufficiently higher than the market price, at prices that are barely profitable or are even below making the e-RA event cost effective. variable costs. 3. Switching costs are acceptable. 4. A sufficient number of qualified, competitive In addition, there continues to be an ongoing controversy suppliers exist in the marketplace. between some sourcing professionals and their top 5. Qualified suppliers of the item(s) are willing to corporate managements regarding awarding business on participate in an e-RA. the basis of lowest TCO versus lowest price. Sourcing professionals argue that higher prices can often result in E-RAs Can Create Markets: The development and use lower total landed costs due to non-price variables such of e-RAs has created competitive “relatively efficient” as suppliers’ superior quality, service, technical ability, markets for many goods and services where none and long-term commitments between the two entities. previously existed. While this “market making” only hints Part of this controversy is caused by the difficulty of at the efficiency of the organized stock, commodity, and measuring the components of total cost versus the currency exchanges, they are substantially more effective transparency of measuring reductions in price. As a result in determining market prices than the traditional static of this transparency, most top managements not only sealed bid or tender processes. embrace the use of e-RA tools, but in some cases, seeing the impressive results of early e-RAs, set aggressive goals Cycle-Time Savings for Buyers and Suppliers: The use for e-RA use in annual sourcing requirements. This can of traditional processes for sourcing goods and services be particularly true when top management learns that the can consume several weeks, months, or more. Much of documented return on investment from e-RA use can run this time is spent in managing several rounds of as high as 10 to 1. This is not to imply that TCO criteria information sharing and negotiation with competing is not used nor accepted for awarding business through suppliers. On the other hand, a successful e-RA requires an e-RA event. To the contrary, there is a growing much greater time and preparation up front. However, acceptance to use TCO criteria as more sophisticated the tradeoff between these extra up-front and back-end e-RAs (and other e-sourcing tools) are developed. efforts versus the hour or so taken to “negotiate” an acceptable price can result in a substantial net reduction in the RFx-to-contract award cycle time. Buying firms Beneficial Aspects of E-RAs report this cycle-time reduction to range from “no significant reduction” to as much as 40 percent over The unique attributes and processes associated with traditional sourcing processes. The majority of suppliers e-RAs can create the following benefits for those firms also believed that e-RAs resulted in decreased cycle times. that employ them. Many felt that e-RAs not only decreased the negotiation phase of the sales process, but could also improve cash Direct Cost Reductions: The major benefit from the use flow. of e-RAs is the potential for measurable direct cost reductions of purchased goods and services through Increased Buyers’ Reach: Because most e-RAs are hosted either price reductions or believable TCO reductions. In through standard (secure) Internet connections, the reach general, reported reductions range from 10 to 20 percent to include qualified suppliers worldwide is increased below historical prices. substantially. Some integrated e-procurement systems

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include semi-automated release, receipt, and analysis of Benefits to Suppliers RFPs or RFQs in multiple language formats. This expanded reach results in providing an effective and Most incumbent suppliers indicate they are reluctant speedy supplier search mechanism. participants in e-RA events, but rarely refuse the chance to retain their current business or increase their business Price Visibility: E-RAs offer the unique opportunity for if supplier consolidation is an objective of the e-RA. In buyers to gain insight into price levels, market prices, contrast, contender suppliers appreciate the chance to price elasticity (as related to various volumes), and price develop new business through their e-RA participation. rigidity (from powerful oligopolies) from suppliers that In addition, suppliers also gain valuable insight into their participate in the event. This knowledge of markets and competitive environment through their own post-event prices can result, in some cases, in a “power shift” from analysis of the outcome. Other potential benefits to strong suppliers to weaker buyers not previously suppliers include lower marketing/sales costs, quicker attainable until information is revealed though an e-RA award/non-award cycle times, and constructive feedback event. from buyers as to why they won/lost the business.

Benefit/Cost Justification: E-RA users justify the set-up and operational costs with their documented hard and Actual vs. Potential Applications of e-RAs soft savings benefits. Reported payback can be achieved after the first few uses of the tool. Nonetheless, there has Most firms indicate their current usage is in the single- been some resistance to the fees charged by full-service digit percentage range of their annual spend. However, providers of e-RAs events. These providers have listened they say the potential is well beyond this range. to their customers and have responded by developing Aggressive users of the tool estimate that the potential less expensive, do-it-yourself systems that are rapidly can be as high as half of their annual spend. Others were gaining acceptance. more conservative in their estimates, indicating that only 10 percent to 15 percent of their spend could be sourced via e-RAs. Whatever the estimate of maximum possible Dysfunctional Aspects of E-RAs spend, none of the firms had yet achieved this level of usage. This strongly suggests that there is substantial Like any tool, e-RAs can be misused or, even if used opportunity for growth in the use of e-RAs. appropriately, can result in a dysfunctional outcome. Here are some of the causes of poor results gleaned by the researchers from the interviews: E-RA Spend Dollars, Percentages, and Trends • Inadequate up-front event planning, unclear item E-RA Event Experience: The range in the number of specifications, and ambiguous auction rules. e-RAs conducted by buying organizations participating in • Insufficient training in the use of the e-RA system the structured interview study was from 21 to 1,900, (buyers and suppliers). with the majority of buying organizations having • Allowing unqualified bidders to participate. conducted over 100 events. Thus, most of these firms can • Misreading the market and setting a reserve be considered “early” or “middle” adopters of the tool (maximum) price that is too far below the market rather than “late” adopters which had only experienced a price, resulting in no bidder responses. small number of e-RA events. • Awarding business to a supplier at a price so low that it cannot deliver as specified or its survival is E-RA Experience across the Global Economy: severely threatened. Estimating the dollar volume of spend awarded through • Targeting the wrong commodity with which to apply e-RAs across the economy, across industries, or across an e-RA, creating an instance where the market will economic regions is not easy. However two useful sources not be responsive, or even suppliers will refuse to of data on e-RA volume are CAPS Research and a survey participate. conducted by the Institute for Supply Management (ISM) • Holding repeated e-RA events for the sole purpose and Forrester Research. CAPS Research conducted two of pressuring incumbent suppliers to reduce their separate polls in 2002 with two diverse sets of large prices. companies, concerning the volume and trends in e-RA • Use of an e-RA that results in destroying the trust usage. and mutual interdependence between the buying company and a key strategic alliance supplier. The first poll indicated that 68 percent of the respondents were using e-RAs. For those companies

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using e-RAs, the rate of usage in 2001 was about 2.6 have low value-add by the suppliers and are already percent of total spend and the expected growth rate was priced with low margins. about 17.5 percent for 2002. The second poll indicated that 83 percent of the companies (N= 46) were using e- RAs. For those companies using e-RAs, the percent of Sustainability of the Use and Economic Value total spend in 2001 was estimated to be about 5.5 percent. For all companies combined, the percent of Add of E-RAs total spend through e-RAs in 2004 was expected to be about 11.5 percent. Sustainability of E-RAs as a Sourcing Tool: Are e-RAs here to stay or just another passing fad of the digital CAPS Research also asked companies in eight industries economy? The skeptics relish the question, the early about their use of e-RAs. Out of 81 responding adopters scoff at the question, and the new adopters are companies, 42 companies (52 percent) indicated that hopeful that they have chosen a winning tool. All of the they were using e-RAs in 2002. The average spend evidence collected in this study suggests that e-RAs are through e-RAs for these companies was 3.6 percent of here to stay and that their use will continue to grow. total spend. These data (and others detailed in this report There are several facts to support this position. from CAPS Research and ISM/Forrester Research) lead to several conclusions. • First, e-RAs have been shown to work — that is, produce cost savings across a wide number of goods, • The percentage of larger firms (over $100 million in services, industries, countries, and economic regions. spend) using e-RAs is at least 35 percent and While there are cases of specific e-RAs failing, this probably over 50 percent. The percentage is lower research found only one firm that had tried e-RAs for smaller firms and non-manufacturing firms. and later abandoned their use. (Even this firm indicated they might try e-RAs again at a future • The average percent of spend going through e-RAs is date.) Furthermore, this research found that the still modest (less than 5 percent), but some firms are success of e-RAs had mostly overcome the early already using e-RAs for over 25 percent of their resistance and philosophical objections to their use. spend. Indeed, this research did not find any firms not using e-RAs because they objected to their use. The • The growth rate in usage is strong (10 to 15 percent non-using firms either had not seen an application increase per year). While most users expect that the for them or had not gotten around to using them. solid cost savings produced by e-RAs may taper off, they also expect that the efficiency of e-RAs will • Second, e-RAs are one of the few new e-tools that continue to fuel the growth in use. can be used in a stand-alone mode (although this may not be the optimal deployment), without Experience across Industries: The use of e-RAs is not integration into ERP or other sourcing systems. limited to a few or selected industries. The research team This makes them relatively low-cost to install and was able to find “power users” in the automotive, use. Many of the fees charged by third-party electronics, aviation, pharmaceutical, construction providers go to support the expertise that the engineering, machinery, chemicals, and packaged goods provider brings to the process, acting as a industries. (The four case studies presented in this report consultant in terms of supplier identification or are examples of these “power users.”) specification writing, for example. Thus, companies can reduce many of the associated fees by using Experience across Commodity Types: Initially, many self-service auctions. firms conclude that e-RAs will find most application in purchasing indirect materials and direct materials that are • Third, e-RAs are a very efficient method of getting commodities or near-commodities. However, upon to a final best price from a group of suppliers. Early reflection, and after some experience with e-RAs, most uses of e-RAs may result in substantial cost savings firms come to the conclusion that e-RAs can be applied that are not sustainable later on. However, the to many areas of their spend, including direct and efficiency remains whatever the outcome. One indirect goods, capital goods, and services. One of the company said that e-RAs resulted in outcomes that CAPS Research polls indicated that the majority of were as good as its best negotiations and better than responding firms used e-RAs most often to buy direct most of its negotiations. Therefore, e-RAs delivered goods, primarily because, for manufacturing firms, the best or near-best results in an efficient manner, even greatest portion of their spend is for direct material, and if the result was not a large cost savings. second, because many indirect and commodity items

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• Fourth, e-RAs are becoming a desktop tool with a services surrounding the goods they now provide to their commodity status. Many providers can provide the customers. Design services, repair services, emergency basic functionality for e-RAs and can place it on the delivers, and so forth would all disappear because the desktop of every buyer. Buyers can arrange e-RAs new low prices would not cover the costs of providing with minimal effort and time. these services. The buyer response to these statements has been three-fold: • Fifth, although not required, many companies are integrating e-RAs into a more complex set of tools. • First, none of the buying companies in this study These tools encompass more of the sourcing process, could identify a case where supplier service had particularly the RFx process. As this integration diminished after an e-RA that resulted in a new continues, buyers will have e-RAs available as a lower price. Thus, the buyers were skeptical of the routine choice, along with sealed bids and traditional claims. negotiations, to complete the buying process. • Second and more importantly, the buyers were As counterpoint, no one quite knows what to expect if interested in testing the value of the un-priced the economy surges and tight supply markets develop. services. If the services had value and were withheld, Two possibilities exist: the buyers would return to the suppliers and explicitly negotiate (or use e-RA) for the services. • The first is that suppliers might organize forward auctions and sell their capacity to the highest bidder. • Lastly, the experienced buying companies in this Many suppliers currently being coerced into e-RAs study were generally confident that they could voice this as a veiled threat. But, it could prove to be include all of the services they needed in the an efficient means to clear markets, just as e-RAs specifications for the e-RA. This would not only have been in a “buyer’s market.” allow suppliers to fairly price and bid on the complete package of goods and related services, but • A second possibility is that both buyers and also allow the buying firms to better know what they suppliers will prefer to abandon e-RAs in favor of were paying for. face-to-face negotiations. However, this return to the “old” way of doing business would sacrifice many of Based on the evidence collected in this study, there is the efficiencies gained by e-RAs. Of course, it is little or no evidence that e-RAs are driving suppliers unlikely that all supply markets will be tight at the into non-sustainable relationships with buyers. In fact, same time. As is true today, e-RAs are applicable only there is evidence to suggest the opposite. E-RAs are in certain circumstances. It seems unlikely that these sharpening the relationships by removing some of the circumstances will disappear altogether under any ambiguity about market prices, forcing buyers to be but the most extreme economic conditions. clearer about what they desire to buy (i.e., better specifications), and forcing suppliers to be clearer about Sustainability of E-RAs’ Economic Value Add: Long- what they are supplying. However, while it is clear that term sustainability of e-RA results (i.e., substantial cost buyers are enjoying the efficiency of e-RAs in getting to a savings) is a question on the minds of most users and price, the efficiency gains on the supplier side are less non-users alike. Logic alone suggests that buying visible. While there is scant evidence from this research companies cannot expect to save, for example 25 percent, that suppliers have been able to reduce sales costs or on repeated buys for the same good and have the personnel because of e-RAs, some sales managers supplier, or even supply base, stay in business. The indicated that they now use their time differently. Prior to companies in this study all suggested that they did not e-RAs they spent a great deal of time in negotiations expect to maintain the same percentage of cost savings on talking about price or cost elements. With e-RAs, they repeated buys. Nonetheless, several companies had spend less time negotiating price face-to-face; this experienced substantial cost savings on the second e-RA function is “delegated” to the e-RA. for the same good. Longer term, most firms indicated the savings will level off and become more driven by the supply-demand conditions at the time of the e-RA. Thus, Non-User Observations and Issues future results could be price increases rather than price decreases. One component of this study included interviews of some buying firms that had never been involved in an Sustainability of Supplier Performance: Many e-RA, or had used them in the past but chose to suppliers interviewed indicated that, as they drop prices, discontinue their use. The following observations and they would not be able to sustain many of the “free” issues emerged from the firms interviewed.

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Reasons for Non-Use: The vast majority of the non-e-RA barriers to the use of e-RAs. In fact, it appears that many user organizations interviewed had firm plans to begin firms who have taken a “wait-and-see” strategy using e-RAs in the near future. Only one of the firms indicated that they could be at a serious competitive interviewed had used an e-RA tool in the past and disadvantage unless they add e-RA tools to their mix of discontinued its use because the savings were no better sourcing strategies. than the firm’s traditional sourcing methods. However, even this firm indicated they planned to return to e-RA use in the near future. Interestingly, none of the firms had Ethical Issues Related to E-RA Use any major philosophical or ethical objections to e-RA use for sourcing certain targeted (i.e., non-strategic) Observed Ethical Issues: Some of the potential (not commodities. When asked why they were only now necessarily observed) ethical issues surrounding e-RAs, as planning to use e-RAs, here are the reasons the firms gave: described by the interviewees, were as follows.

• First, all interviewees were aware of the general • Buyers using e-RAs can force suppliers out of nature of e-RAs, but some had higher priorities and business by accepting what they know to be limited resources to devote to their use. In addition, unreasonably low prices. some firms had received proposals from third-party • Buyer pretends to be a supplier in the e-RA event e-RA service providers with fees they thought were and bids low to force down price. too high when compared to expected benefits. • Buyer includes suppliers in e-RA who are not pre- However, recent publicity about e-RA value had qualified and probably not viable. changed their minds, and some were planning pilots. • Suppliers engage in collusion. • Supplier bids unrealistically low price. • A small number reported that only a few of their • After winning the business based on low price, the procured items were suitable for e-RA application, supplier then recoups profit by charging for change primarily because they had several long-term orders. contracts in place that would not expire for a few • Suppliers “participate” in an auction but don’t bid, years, or e-RAs would not be appropriate for their with goal of gaining market intelligence. key “strategic” suppliers. • Supplier cannot deliver product/service as promised. • After the e-RA event is closed, another supplier • One responding firm indicated that it was so highly meets or beats the low bid and is awarded business, decentralized that it would find it difficult the get based on either buyer’s or supplier’s initiative. enough aggregate demand to make e-RAs cost • Low prices “force” some suppliers to cut corners in effective. the safety arena.

• A few interviewees expressed concern that their Some buyer organizations, while addressing at least some suppliers may not participate, or not enough of the ethical issues shown above, stated that e-RAs are qualified competitors would join the e-RA event. no different from traditional negotiations with regard to ethical improprieties. Another group of buying • Some minor resistance from internal clients and top organizations stated that e-RAs actually improved the management was voiced, but this was not a major state of ethics and fairness by making the sourcing deterrent to e-RA use. process more objective (e.g., through the elimination of cronyism and supplier “wining and dining”) and more • When asked if they were concerned about the transparent, as suggested by the following statements fairness of e-RA processes, a few rumored anecdotal from purchasing and supply managers: stories about phantom bidders, but generally, the respondents were not concerned. In fact, some of the • “Now all suppliers get the same information at the non-using firms asked the interviewers to give same time — this increases fairness.” examples of what was meant by “unethical practices” with e-RA use. • “[E-RAs] change the ‘old boy network’ of sourcing.”

• There was some concern about the nature of the • “[There is] no more hiding bad performance of the e-RA systems’ range of capabilities and their ease of buyer, and no more lying to the supplier.” use. However, this was not a major issue. • “[E-RAs] eliminate cronyism, just as does job Conclusions Regarding Non-Users: In summary, this rotation and giving buyers new materials groups component of the study did not reveal any serious every three years. [E-RAs] eliminate cronyism

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without having to put buyers through frequent learning curves.”

Several suppliers interviewed echoed sentiments similar to those of their buyer counterparts regarding a lack of distinction between ethical issues prior to and after the introduction of e-RAs. Counter to some of the recent assertions found in the trade press, some of these suppliers also stated that e-RAs were a fairer process of awarding business, indicating that e-RAs helped to “level the playing field” through increased transparency.

Conclusions

• For a growing number of buying firms, e-RAs have found an appropriate niche in their strategic sourcing toolkit, allowing them to efficiently source goods and services that are highly standardized, have sufficient spend volume, can be replicated by a reasonable number of qualified competitors, and have insignificant switching costs. In contrast, the research indicates that those suppliers of strategic items, where alliance-level supplier relationships are critical, are usually not subjected to e-RA sourcing.

• Reported payback usually can be achieved after the first few uses of the e-RA tool.

• There is little or no evidence that e-RAs are driving a significant number of suppliers into non-sustainable relationships with buyers.

• Firms who have taken a “wait-and-see” strategy indicated that they could be at a serious competitive disadvantage unless they add e-RA tools to their mix of sourcing strategies.

• Buyers believe that e-RAs are no different from traditional negotiations with regard to ethical improprieties, and suppliers indicate that e-RAs, in general, are a fairer process of awarding business, because they “level the playing field” through increased transparency.

• E-RAs are here to stay and that their use will continue to grow.

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Executive Overview

e-RA

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Conduct e-RA

E-RA

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Firm size

Spend through e-RAs

Future growth

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Introduction

In the mid-1990s, a new electronic sourcing tool emerged to the traditional “sealed bid” process where suppliers that has had, and is continuing to have, a profound respond to a request for Quote (RFQ) from the buying impact on the way in which firms source goods and firm. services from current and potential external suppliers. This tool, while known by other names (e.g., “online In an e-RA, the bidder with the lowest price (or lowest negotiation”) is the electronic reverse auction (e-RA). total cost) is usually awarded the business, but the buying organization can specify in advance of the e-RA The purpose of this study is to present the initial results that business may not be awarded to the low-price of a comprehensive study of e-RAs undertaken by CAPS bidder, or for that matter, to any supplier, if bids do not Research during 2002. meet its targeted price and non-price requirements. (It should be noted that, during an e-RA, some buying firms report, in real time, the lowest current price to all Defining E-RAs competitors during the event, while others only show how each supplier’s last price bid ranks in comparison to In its basic form, an e-RA is an online, real-time dynamic the other suppliers’ last price bid. Showing only rank auction between a buying organization and a group of comparisons mitigates some suppliers’ reluctance to share pre-qualified suppliers who compete against each other specific price information with their competitors as well to win the business to supply goods or services that have as encourages them to continue bidding rather than clearly defined specifications for design, quantity, quality, dropping out.) delivery, and related terms and conditions. These suppliers compete by bidding against each other online over the Internet using specialized software by submitting successively lower priced bids during a scheduled time period. This time period is usually only about an hour, but multiple, brief extensions are usually allowed if bidders are still active at the end of the initial time period.

Reverse vs. Forward Auctions

The term “reverse” auction is in contrast to a traditional “forward” auction where bidders offer successively higher prices until a winner is declared by the auctioneer. Nor is an e-RA like a “Dutch” auction where the supplier successively drops the price of an item being auctioned, in fixed decrements, until one of the competing buyers accepts the proposed price. Finally, an e-RA’s dynamic process (multiple rounds of bidding) is in sharp contrast

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Objectives of the Study

The objectives of the study are as follows: • Third-party providers of e-RA services (e.g., eBreviate, FreeMarkets) • Understand the nature of e-RAs in their various • A targeted number of firms who had specifically forms and functions. chosen not to use e-RA tools for sourcing • Determine both the current and potential economic value added (EVA) for both buying and supplying A detailed description of the study’s methodology is participants resulting from their use (or non-use) of shown in Appendix A. e-Ras. • Determine what forms of e-RAs are best suited for different commodities, economic conditions, buyer- supplier interdependencies, supply/demand dynamics, and strategic sourcing initiatives. • Compare and contrast the experiences from buying and supplying firms that do/do not participate in e-RAs, including the perspectives of third-party e-RA service providers. • Explore the decisions of those firms that choose not to participate in e-RAs. • Understand the issues related to buyer-supplier professionalism and ethics associated with e-RA deployment. • Understand the role and EVA of e-RAs in firms’ overall strategic sourcing processes.

Overview of the Study’s Methodology

The study’s methodology consisted primarily of analyzing face-to-face and teleconference-structured interviews performed in the United States and Europe during mid- 2002, with the following organizations:

• A targeted number of firms who were considered to be “power users”* of e-RAs for sourcing goods and services from external suppliers • A targeted number of suppliers who had participated in e-RA events

*“Power users” are large multi-national firms that were determined to have had extensive experience with e-RAs.

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Why E-RAs?

Why the intense interest in e-RAs? The dramatic growth • Recent order-of-magnitude improvements in quality of the use of e-RAs over the past few years has been and cycle-time reductions have resulted in buying facilitated both directly and indirectly by a number of companies perceiving superior quality and service as converging internal and external developments and “givens.” Thus, they have shifted their emphasis forces, including: toward low price as a major sourcing decision variable. • An intense need by firms to reduce costs of • Emergence of sophisticated and disciplined strategic externally sourced goods and services (often sourcing processes that enable buyers to amounting to 60 percent or more of total costs of systematically use various e-tools (including e-RAs) goods sold) to become or remain competitive in the to increase their competitiveness. challenging economic environment of the late 1990s • Increased emphasis on global sourcing due to a and early 2000s. combination of drastically improved quality of goods • Aggressive initiatives by firms to rationalize (usually and low labor costs from developing countries. reduce) their supply base and give more business to fewer suppliers or, alternatively, add new sources as a The birth and acceptance of e-RA tools has not been hedge against risk. without controversy, because, for some, its process is • Increased ability to aggregate company-wide demand contradictory to the long-term benefits associated with for sourced goods and services through integrated collaborative/cooperative buyer-supplier alliances. This ERP systems and thus, facilitate standardization and perceived conflict is primarily caused by the tool’s SKU reduction. emphasis on awarding business based on aggressive price • Widespread ability for buyers and suppliers to competition (the classical arm’s length coercive/ economically communicate in real time, worldwide, competitive model) instead of long-term total cost of via the Internet. ownership (TCO) considerations. However, for a growing • Development of robust, user-friendly Internet-based number of firms, e-RAs have found an appropriate niche software systems to support worldwide e-RA events in a strategic sourcing toolkit, allowing firms to efficiently that are either hosted by a third party or designed to source goods and services that are highly standardized, be run by the buying company with little or no can be replicated by competitors, and have insignificant outside assistance. switching costs. In contrast, those suppliers of strategic • Many buying organizations have recently enjoyed a items, where alliance-level supplier relationships are buyers’ market where excess supplier capacity exists, critical, are usually not subjected to e-RA sourcing. and suppliers are willing to reduce prices, in some Generally, suppliers asked to participate in e-RAs, cases, just to cover variable costs. especially incumbent suppliers, do so reluctantly for fear • Intense initiatives by suppliers to reduce their total of losing business. Overall, incumbent suppliers win costs has often resulted in increased margins that about half of the e-RA events in which they participate, may not have been passed on to their customers in with the balance going to contender suppliers, sometimes price reductions, especially if they enjoy at prices that are barely profitable or are even below differentiated oligopoly or niche market power. variable costs.

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Top Management’s Expectations and Support of E-RA Use

There continues to be an ongoing controversy between some sourcing professionals and their top corporate managements regarding awarding business on the basis of lowest TCO versus lowest price. Sourcing professionals argue that higher prices can often result in lower total landed costs due to non-price variables such as suppliers’ superior quality, service, technical ability, and long-term commitments between the two entities. Part of this controversy is caused by the difficulty of measuring the components of total cost versus the transparency of measuring reductions in price. As a result of this transparency, most top managements not only embrace the use of e-RA tools, but in some cases, seeing the impressive results of early e-RAs, set aggressive goals for e-RA use in annual sourcing requirements. This is especially the case when top management learns that the documented return on investment from e-RA use can run as high as 10 to 1. This is not to imply that TCO criteria is not used nor accepted for awarding business through an e-RA event. To the contrary, there is a growing acceptance to use TCO criteria as more sophisticated e-RAs (and other e-sourcing tools) are developed.

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Benefits/Dysfunctional Aspects of E-RAs

The unique attributes and processes associated with • There is a strong likelihood that the current price is e-RAs can create the following benefits and issues for sufficiently higher than the market price so as to those firms that employ them. make the e-RA event cost effective. • Switching costs are acceptable. • A sufficient number of qualified, competitive Direct Cost Reductions suppliers exist in the marketplace. • Qualified suppliers of the item(s) are willing to The major benefit from the use of e-RAs is the potential participate in an e-RA. for measurable direct cost reductions of purchased goods and services through either price reductions or believable All of the firms in the study believed that if good TCO reductions. In general, reported reductions range specifications could be written and if a competitive from 10 to 20 percent below historical prices. supply market existed, then an e-RA was a viable approach to purchasing the good or service. The converse is also true, as several companies discovered in unsuccessful e-RAs. (In fact, a subsequent benefit was Biddable Attributes the resulting unambiguous, clear specifications that were developed in preparation for the e-RA.) Several firms Is everything a company buys a candidate for e-RA reported that they had tried e-RAs for commodities that application? The answer clearly is no. Especially exempt were controlled by just two or three major suppliers. The are items or services that do not have clearly defined suppliers essentially refused to meaningfully participate, attributes that competing suppliers can translate into resulting in a failed e-RA. Likewise, e-RAs for which unambiguous specifications (e.g., software development, suppliers were provided with incomplete or confusing skilled contract labor). Second are items that are highly specifications resulted in suppliers bidding on essentially differentiated strategic items supplied by firms that different items. The result was that the low bid in some are tightly coupled through strategic alliances with cases was not acceptable because it was not responsive to the buying firm (e.g., jet engines for an aircraft the intended buy. manufacturer). Third are instances in which switching suppliers would result in unacceptably large change costs (e.g., unique, proprietary process with no acceptable substitutes, re-certification of flight hardware by NASA). E-RAs Can Create Markets Fourth are items where the volume or value is so low that the potential savings do not cover the cost of holding the Clearly, the development and use of e-RAs has created event. competitive “relatively efficient” markets for many goods and services where none previously existed. While this What then, are the major attributes of a biddable good or “market making” only hints at the efficiency of the service? In general, they are: organized stock, commodity, and currency exchanges, they are substantially more effective in determining • Items can be clearly specified (design, terms, and market prices than the traditional static sealed bid or conditions) and translated into prices a supplier will tender processes still in wide use throughout the world. commit to charge the buyer. As a marketing strategy, suppliers traditionally have relied

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upon buyers’ lack of knowledge about market prices and “E-RAs decrease cycle times because when a acceptable substitutes for their products and services. In customer signs up [with an e-RA provider], the addition, suppliers spend considerable effort to customer has to schedule an event, and it is difficult differentiate their products to divert attention from price for the buying company to keep changing the date of to non-price features. E-RAs, on the other hand, provide the event, so the customer has to drive themselves to a practical mechanism to bring several suppliers together meet that date.” with one buyer to “make a market” for a broad range of non-pure commodities, such as highly engineered parts, specialty chemicals, PCs, MRO, and services such as Increased Buyers’ Reach temporary labor, maintenance, and transportation. Because most e-RAs are hosted through standard (secure) Internet connections, the reach to include qualified Cycle-Time Savings for Buyers and Suppliers suppliers worldwide is increased substantially. Some integrated e-procurement systems (usually provided by The use of traditional processes for sourcing goods and third parties) include semi-automated release, receipt, services can consume several weeks, months, or more. and analysis of RFxs in multiple language formats. Prior The cycle-time from issuing a request for information to the auction, these RFxs are sent electronically to (RFI), request for proposal (RFP), or request for quote suppliers that have been identified by the buying firm or (RFQ) (all generically termed RFx), to contract award can that may have been pre-qualified by the service provider. be painfully long and consume a substantial amount of This expanded reach results in providing an effective and time and effort from professional buyers. Much of this speedy supplier search mechanism. time is spent in managing several rounds of information sharing and negotiation with competing suppliers. On the other hand, a successful e-RA requires much greater Total Cost Analysis time and preparation up front in order to correctly and adequately specify the requirements, select suppliers to While TCO analysis of bids is available in most e-RA participate in the event, and communicate and coordinate systems, it is used explicitly only by the most advanced with suppliers. One supplier said, “The more information user of the tool. Some systems allow for the integration of that the buying organization can provide, the better a dozen or more variables to be factored into a price bid position the supplier is in to respond.” In addition, post- during the event. This is usually done by adjusting each e-RA negotiations can also consume substantial time and supplier’s bid price up or down based on a pre-e-RA effort. However, the tradeoff between these extra up-front analysis of each competing supplier’s performance in and back-end efforts versus the hour or so taken to relation to the non-price variables. Often, these variables “negotiate” an acceptable price can result in a substantial are weighted to reflect their relative importance. On the net reduction in the RFx-to-contract award cycle time. other hand, buyers that announce that the business may Buying firms report this cycle-time reduction to range not necessarily be awarded to the low-price bidder are from “no significant reduction” to as much as 40 percent implicitly considering non-price factors in determining over traditional sourcing processes. The result of this who will win the business, and thus are de facto users of greater up-front preparation is a significant shortening the TCO criteria. and compression of the negotiation period into a 30- to 90-minute event.

The majority of suppliers also believed that e-RAs Price Visibility resulted in decreased cycle times. Many felt that e-RAs not only decreased the negotiation phase of the sales E-RAs offer the unique opportunity for buyers to gain process, but could also improve cash flow: “With a non- insight into price levels, market prices, price elasticity (as e-auction it may take [our company] eight months to see related to various volumes), and price rigidity (from any revenue; with an e-auction, it may take only three powerful oligopolies) from suppliers that participate in months to see revenue.” Like their buyer counterparts, the event. The use of e-RAs, however, will not guarantee suppliers also emphasized the decrease in negotiation that the low-price bid is the true market price. This is cycle times, where multiple face-to-face price negotiations because the low bidder may be willing to go even lower that might have occurred over several weeks were than true market price, but the competitors in the event condensed into a period of a few hours. Finally, suppliers are not. Nonetheless, price visibility, in general, is more noted that the scheduling process of an e-RA can transparent through e-RAs than in traditional sourcing minimize the possibility of buyers postponing bid processes. This knowledge of markets and prices can deadlines: result, in some cases, in a “power shift” from strong

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suppliers to weaker buyers not previously attainable until more professional, value-added activities beyond information is revealed though pre-event RFx traditional negotiations, as described by one German submissions, the event, and post-event analyses. purchasing executive:

“The target of a purchasing manager is to do as Transparency of the Purchasing and Supplying many saving projects as possible. So, if you can do one part with electronic tool support, it gives you Processes more space or time to focus on new suppliers, on worldwide supplier search, and on traditional If fairly administered, both the buying firm and the negotiations where an auction is not appropriate.” supplying firms have a clearer level of transparency into purchasing and supplying processes. Buying firms spend more up-front time defining specifications for the items to be auctioned, determining what suppliers are qualified Other/Indirect Savings to be awarded the business, and gaining insight into the supply market’s nature by analyzing pre-event, event, and The effective use of e-RAs can result in a ripple effect of post-event behaviors. Likewise, suppliers have a clearer cost reduction in such areas as shorting the cycle-time of picture of what they are expected to deliver, have an new product introduction, higher inventory turnover, opportunity to retain current business or gain new quicker introduction of lower-cost materials, more business, and are less impacted by non-rational decisions effective use of sourcing professionals, and, in some cases, made by buyers or internal customers that want to headcount reduction due to automation of some maintain status quo. components of the sourcing process.

Overall Process Efficiency/Productivity Benefit/Cost Justification

Users of e-RAs report that they are able to spend less time E-RA users justify the set-up and operational costs with on managing the tactical and operational logistics of their documented hard and soft savings benefits. Reported sourcing, thus enabling them to spend more time on payback can be achieved after the first few uses of the tool. such strategic sourcing functions as spend analysis, (One user reported that the investment in an e-RA system opportunity assessment, market evaluation (e. g., paid for itself during the first five minutes of their first performing Porter’s five forces analysis), developing event!) Nonetheless, there has been some resistance to the commodity sourcing strategies, identifying potential fees charged by full service providers of e-RAs events. suppliers, current supplier development, supplier These providers have listened to their customers and have evaluation, and contract administration. Because the e-RA responded by developing less expensive do-it-yourself event drastically shortens the cycle-time of price (or systems that are rapidly gaining acceptance. TCO) negotiation, more time can also be spent on pre- event planning and post-event negotiation issues. Dysfunctional Aspects of E-RAs Specifically, user companies indicated that the use of reverse auctions has enhanced their professional buyers’ Like any tool, e-RAs can be misused, or, even if used productivity. One user company estimated a 25 percent appropriately, can result in a dysfunctional outcome. reduction in cycle-time to source a part. Other buying Some of the causes of poor results gleaned from the organizations said, “Therefore there is more throughput interviews are: per buyer,” and “[E-RAs] are just a tool that results in increased productivity.” Reverse auctions also force buyers • Inadequate up-front event planning or unclear item to structure the bidding rules prior to the event, to specifications and auction rules. standardize the procurement process, and to often times • Insufficient training in the use of the e-RA system develop a strategy for their purchased items or material (buyers and suppliers). groups. However, these activities may not result in • Allowing unqualified bidders to participate. increased productivity for buyers until they become • Misreading the market and setting a reserve accustomed to the e-RA process and have conducted (maximum) price that is too far below the market repeat e-RAs. price, resulting in no bidder responses. • Awarding business to a supplier at a price so low The fact that buyer productivity is increased also frees the that it cannot deliver as specified or its survival is time of buyers and purchasing managers to undertake severely threatened.

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• Targeting the wrong commodity with which to apply an e-RA, creating an instance where the market will not be responsive, or even suppliers will refuse to participate. • Holding repeated e-RA events for the sole purpose of pressuring incumbent suppliers to reduce their prices. • Use of an e-RA that results in destroying the trust and mutual interdependence between the buying company and a key strategic alliance supplier.

Benefits to Suppliers

As discussed earlier, most incumbent suppliers indicate they are reluctant participants in e-RA events, but rarely refuse the chance to retain their current business or increase their business if supplier consolidation is an objective of the e-RA. In contrast, contender suppliers appreciate the chance to develop new business through their e-RA participation. In addition, suppliers also gain valuable insight into their competitive environment through their own post-event analysis of the outcome. If they win the business while maintaining a decent margin, that indicates they probably are competitive. Likewise, if they lose the business to a competitor, that indicates their cost structure and/or their margin requirements may need to be leaner.

Other potential benefits to suppliers might include lower marketing/sales costs and quicker award/non-award cycle times (Sometimes awards are announced at the end of the event, or a day or two later versus weeks or months under traditional sourcing processes). Suppliers also cited the benefits of constructive feedback from some buyers as to why they won/lost the business if they were not/were the low-price or highest ranked bidder.

Actual vs. Potential Application of E-RAs

What is the reported potential for using e-RAs for sourcing? Most firms indicate their current usage is in the single-digit percentage range of their annual spend. However, they say the potential is well beyond this range. Aggressive users of the tool estimate that the potential can be as high as half of their annual spend.

Others were more conservative in their estimates, indicating that only 10 percent to 15 percent of the spend could be reverse auctioned. Whatever the estimate of maximum possible spend, none of the firms had yet achieved this level of usage. This strongly suggests that there is substantial opportunity for growth in the use of e-RAs.

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The Strategic Context of E-RAs

The use of an e-RA tool is but one component of a buying variation in how this process is depicted. The process firm’s strategic sourcing process and is not designed to be shown here is an amalgamation (and simplification) of used to source all of a firm’s requirements for purchased several of these depictions, and is not attributed to any good and services. Rather, it is one alternative to use with specific organization’s model.) other sourcing strategies such as vertical strategic buyer- supplier alliances, horizontal purchasing consortiums, What follow is a brief discussion of each of these eight e-marketplaces, spot buys, outsourcing all or part of the chevrons in the graph. However, the focus of this sourcing function, and even in-sourcing, where external research is on the six components in the middle, with supply markets fail to deliver adequate added value. Thus, specific emphasis on interviewees experiences with the it is appropriate to show where the e-RA tool fits into a two elements most darkly shaded (Develop Reverse firm’s typical e-oriented strategic sourcing process. Auction Strategy and Hold Reverse Auction).

The E-Oriented Strategic Sourcing Process Spend Analysis and Opportunity Assessment

Figure 1 shows the major components in a firm’s typical Step One in the e-oriented strategic sourcing process is e-oriented strategic sourcing process. (Note: There is a wide to capture and analyze current and potential spend through

Figure 1 Components of Typical E-Oriented Strategic Sourcing Process

e-Strategic Sourcing Process

Spend Analysis & Develop Identify Issue & Develop Hold Award Follow-up e-Sourcing Potential & Evaluate Reverse Reverse Business if and Opportunity Assessment Strategy Qualified Returned Auction Auction Conditions Re-Sourcing Suppliers e-RFxs Strategy Met

Focus of this Research

Develop Identify Issue & Develop Hold Award e-Sourcing Potential & Evaluate Reverse Reverse Business if Strategy Qualified Returned Auction Auction Conditions Suppliers E-RFxs Strategy Met

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a “dump” of files from accounts payable and other data Bottleneck: An electronics company purchased a large mining opportunities available from ERP systems. In number of “quick turn” printed circuit boards for product addition, firms report they use standard Pareto and other development. The boards were made-to-order with short market analysis tools (e.g., Dun & Bradstreet, Hoover’s, lead times and the number of suppliers was limited. The Thomas Register, and industry-specific services such as boards were not used in production so the purchase iSupply) to determine where opportunities exist for the volume was low. The electronics company was able to application of a formal strategic sourcing process. This reduce its costs for the prototype boards by using e-RAs can be done for all sources of spend, including direct and in conjunction with a program of early supplier indirect materials, services, and capital expenditures. involvement in the board design. Following this initial analysis, firms often categorize their spend into the classic 2 x 2 matrix to determine the Leverage: A machinery manufacturing firm reported that appropriate sourcing strategy or tactic. See Figure 2. they had been paying too high a price for plastic molded pieces. Although there were several suppliers for the In general, e-RAs have been used for sourcing three of product and the price for the base resins fluctuated, the the four cells of the sourcing strategy matrix: commodities, price paid for the molded plastic parts tended to be fixed. leverage, and bottleneck direct and indirect materials, An e-RA was organized with the incumbent and several services, and capital goods. Only for strategic items, other qualified suppliers that resulted in a substantial which often involve long-term strategic relationships with price reduction. suppliers and high switching costs, have e-RAs not found great application. Discussion of the use of e-RAs in each Non-critical: A specialty chemical company used e-RAs to cell follows. buy packaging material. The product was considered a commodity and the need was not urgent. The supply Strategic: An aviation company interviewed defined base included many suppliers (international and propulsion and avionics systems to be strategic goods. domestic); some were pre-qualified and some were not. The suppliers had participated in the early development Two suppliers won the e-RA, one of which was pre- of these systems for specific aircraft and were under long- qualified while the other was not. The pre-qualified term contracts to support the systems for the life of the supplier was awarded 100 percent of the business, while aircraft. For these reasons, the aviation company did not the other was offered the opportunity to become envision a role for e-RAs in buying these systems. qualified. A purchase price decrease of 20 percent achieved, plus one new supplier was later qualified.

Figure 2 Sourcing Strategic Matrix

Leverage Strategic

Commodities Bottleneck

Adapted from: Kraljic, Peter, “Purchasing Must Become Supply Management,” Harvard Business Review, September- October, 1983, pp. 111-112.

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In addition to being employed to buy direct and indirect analyses/opportunity assessment, e-design collaboration, materials, e-RAs have also found use in the purchase of e-supplier evaluation, e-award/decision support (with services and capital. Some examples follow. optimization), e-invoicing, and e-funds transfer.

Services: A construction engineering company routinely Thus, Step Two in the e-oriented strategic sourcing used e-RAs to purchase construction services for cell process is to determine the appropriate mix of available phone transmission towers. The suppliers bid according e-sourcing tools to use for the items or services under to their ability to perform the service and, most evaluation. importantly, their open capacity or their need for the business. Many of the same suppliers participated in the e-RAs. The winning bids are routinely lower than the Identify Potential Suppliers estimated construction cost. Step Three is to identify potential suppliers for the items Capital: A pharmaceutical company used an e-RA to buy or services being subjected to the e-oriented strategic capital equipment for its laboratories. The winning bid sourcing process. This is done most often by tapping the was lower than the estimated cost prior to the e-RA. An experience a firm has with its current supply base as well airline and a telecommunications company were using as using the firm’s supply management staff to conduct e-RAs to buy facilities. searches for new suppliers. In some cases, firms make use of external consultants that have item category expertise Other spend categories: One last category of spend that is or e-RA providers who offer supplier search services. of interest is commodities that have a published price index. There actually are two categories of commodities The search for potential suppliers may or may not be with indices. First, there are commodities that are traded successful, but usually, a potential list appears that may on an organized exchange, for which the minute-to- range from one to several dozen. From this list, the next minute current prices are known, plus for which future step (step four) is to pare the list down to a reasonably markets are established. (Many agricultural products fall sized list of qualified suppliers through the RFx process, into this category.) No cases were observed of e-RAs which may or may not be e-enabled. being used to purchase such commodities, nor does it seem likely that e-RAs would ever be used for this class of commodities. While not all transactions for such commodities are processed through the established Issue and Evaluate Returned RFxs exchanges, price discovery is not an issue when two parties are negotiating a private transaction for these Step Four entails issuing an appropriate RFx to the commodities. Therefore the value-add of an e-RA would broader list of potential suppliers. The RFxs may or may be quite small. not be e-based. Suppliers responding to the RFx are then evaluated to determine those that are qualified to be There are also commodities that are not traded on an invited to participate in a e-RA. Finally, if the list of exchange, but for which a price index is published qualified suppliers is too small (one, maybe two, in some regularly that reflects transactions reported to the cases) or too large to be handled logistically, the final list publishing agency. (Memory chips are an example of such of invitees may be decreased or increased by an a commodity.) In this case, some providers have reported additional supplier search and/or inviting suppliers that they have hosted e-RAs that routinely result in bids believed to be potentially qualified. that beat the published index. This could be due to imperfections in the index or could be just a matter of timing. While none of the study’s case firms reported using Develop Reverse Auction Strategy e-RAs for this class of commodities, other firms might be. As mentioned earlier, an e-RA is but one tool in an e-oriented strategic sourcing process. In fact, the list Develop E-Sourcing Strategy below shows a sampling of the various strategies and tactics that may be used individually, or in combination, Firms that are, or are becoming e-sourcing oriented, have to develop an overall strategy to source a good or service, a variety of e-sourcing tools available to use, and more depending upon the specific economic and technical are under development. In addition to e-RA and e-RFx environments facing the buying and supplying firms. tools, new e-sourcing tools that are complementary to (Note that e-RAs are just one of many sourcing strategies e-RAs and e-RFxs are becoming available such as e-spend and tactics.)

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Generic sourcing strategies and tactics (both traditional variables will be considered (such as switching costs, and e-oriented): quality, and delivery performance), and in fact, that they may not award any business to any bidders • Strategic alliance for high value/high risk strategic unless certain conditions are met? Furthermore, commodity what are these conditions? • Traditional face-to-face negotiation, perhaps only • At what level will the buying firm reveal to the with key alliance suppliers bidders the maximum (reserve) price they will • Traditional sealed bid process (low volume/low accept before awarding any business and its own value, “C” items) internal (confidential) target price they are hoping to • Negotiated or non-negotiated catalog buy, with achieve through the auction to justify the cost of p-card authorization (to control maverick buying) holding the e-RA event and incurring switching • Aggregation of an item’s demand across divisions, costs, if the incumbent is not the low-price bidder? nationally and globally • Should the buying firm award all of the business to a • Component standardization (SKU reduction) single supplier (to gain price-volume leverage) or to • Source domestically and/or globally multiple suppliers for continuity of supply, capacity • Supplier-managed inventory with/without limitations, or regional demands? consignment • What will the buying firm do if no suppliers agree to • Spot buys from formal commodity markets (e.g., participate or no serious bids are submitted? sweetener, orange juice, pork bellies, jet fuel) • What will be the specific rules for the e-RA event? • E-reverse auctions of appropriate goods and services (generally, commodities, leverage, and bottleneck items as shown earlier in Figure 2, but Hold the Reverse Auction not strategic items) • Outsource of all or part of the procurement function Step Six is to hold the e-RA. As mentioned earlier, this (Ariba, CommerceOne) can be hosted entirely by the buying firm or with partial • Source through a buying consortium (O’Hare Group) or full help from a service provider. Later sections of this or third-party e-market (ChemConnect) report will provide the details on the mechanics of e-RA • Single/multiple source (supply base rationalization) events, along with research findings detailing how they • Take partial ownership position of supplier are deployed.

However, the decision to use an e-RA to source a specific good or service in itself requires the development of an e-RA strategy, which is Step Five, in the e-oriented Award Business If Conditions Are Met strategic sourcing process. A sampling of some e-RA strategy questions to be considered follow: Step Seven in the e-oriented strategic sourcing process is to decide which bidder or bidders, if any, should be • Should the buying firm aggregate all of its spend in awarded the business. Here are the major options this category for an e-RA event, or run separate e-RA observed in the study: events for different product divisions, locations, etc.? • Should the buying firm hold an e-RA for sourcing a • Award business to one or more bidding suppliers single-item category (standard-sized rental cars from based only on lowest price. Hertz, Avis, Budget, etc.); or a group of similar items • Award business to one or more bidders that may or (rental cars and trucks from Ford, GM, etc.); or may not have been the low-price bidder(s), after multiple dissimilar items (rental cars, air travel, hotel considering non-price variables (quality, delivery, rooms from a competing group of travel agencies)? switching costs, etc.). • Should bidders be required to bid on entire packages • Award business to one or more bidders only after (cars, air travel, hotel rooms) or be allowed to conducting post-e-RA negotiation session(s) with “cherry pick” what they bid on (hotel rooms only)? selected bidder(s). Likewise, will the buying firm inform the • Decide not to award the business to any bidders competitors up front that they may “cherry pick” and because pre-e-RA conditions or post-e-RA evaluation award business for rental cars to one supplier, air and/or negotiations were not satisfactory. fare to another, and hotel rooms to a third, or other combinations? While the details regarding the incidence of these award • Will the buying firm guarantee that the lowest-price alternatives are discussed later in this report, one bidder will definitely be awarded all of the business? interesting observation is that incumbent suppliers are Or, will they announce in advance that non-price awarded the business sourced through e-RAs about half the time.

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Follow-Up and Re-Sourcing

Step Eight entails an ongoing formal process for evaluating the performance of the winning bidder(s) to see if they have met the conditions of the e-RFx, and, if applicable, the post-e-RA negotiated terms and conditions. While most firms still use traditional, non- e-tools for this step, providers are beginning to offer e-supplier evaluation models in their suite of applications (e.g., Open Ratings).

Finally, “re-sourcing” refers to a buying firm’s plan to re-bid the business with a future e-RA or return to more traditional strategic sourcing process, once the current contract nears expiration. For example, some buying firms have used an e-RA to choose a new strategic supplier, but would not consider subjecting that supplier to a future e-RA because of the need for close collaboration between the two firms. On the other hand, for a repeat buy of a leverage item, the buying firm may award a short-term contract (one year or less) with the intent of holding periodic e-RAs for this item if it believes there is still some price (or TCO) savings to be realized. Unfortunately, the timing of this study (mid-2002) did not provide much experience relating to re-sourcing due to the relative infancy of the tool’s use.

The Interaction of E-RAs and the Other Components of the Strategic Sourcing Process

An e-RA, albeit a tool that is growing in importance in a firm’s strategic sourcing process, is but one “e” device to use in sourcing goods and services. However, its expanding use is expected to have a substantial impact on several of the strategic sourcing components shown in Figure 1. One reason for this potential impact, as mentioned earlier, is the current development of new e-sourcing tools that are complementary to e-Ras, such as e-spend analyses/opportunity assessment, e-RFx deployment and analyses, e-design collaboration, e-supplier evaluation, e-award/decision support (with optimization), e-invoicing, and e-funds transfer. These e-tools are being developed and deployed by some buying firms (see the GlaxoSmithKline case study) as well as third-party solutions providers (e.g., FreeMarkets and eBreviate). It is envisioned that this new breed of e-tools could provide a means to integrate the components of the strategic sourcing process and perhaps other links in the supply chain.

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Spend Dollars, Percentages, and Trends

E-RA Event Experience to so-called “do-it-yourself” e-RAs, the activity and outcomes are not visible to the providers of the e-RA The range of e-RAs conducted by buying organizations software. participating in the structured interview study was from 21 to 1,900, with the majority of buying organizations A third difficulty in compiling statistics about e-RA usage having conducted over 100 events. Thus, most of these is that not all companies and providers use the same firms can be considered “early” or “middle” adopters of counting system. For example, one provider counts each the tool rather than “late” adopters which had only separate e-RA in a multi-e-RA event as one e-RA, while experienced a small number of e-RA events. another provider counts a multi-e-RA event as one event. These counts are clearly not comparable.

Experience across the Global Economy Two useful sources of data on e-RA volume are CAPS Research and a survey conducted by the Institute for Supply Management (ISM) and Forrester Research. Knowing the dollar volume of spend awarded through e-RAs and the trends in this area can help managers CAPS Research conducted two separate polls in 2002 benchmark their activity in this area and help them with two diverse sets of large companies, concerning the define the appropriate role of e-RAs in their overall volume and trends in e-RA usage. The first poll indicated sourcing strategy. However, estimating the dollar volume that 68 percent of the respondents were using e-RAs. (See of spend awarded through e-RAs across the economy, Table 1.) For those companies using e-Ras, the rate of across industries, or across economic regions is not easy. usage in 2001 was about 2.6 percent of total spend and There are several reasons for this. First, companies do not the expected growth rate was about 17.5 percent for routinely report these data. Second, providers of e-RA 2002. services do not report total activity, except in general and often in conflicting terms. Furthermore, most providers The second poll indicated that 83 percent of the of e-RA software and functionality do not know the full companies (N=46) were using e-RAs. For those extent of use of their products. As more companies move

Table 1 CAPS Research Large Company Survey

Spring 2002 (N=114) Fall 2002 (N=46) Percent of companies using e-RAs 68% 83% Average number of e-RAs in 2001 20 NA Average $ value of an e-RA in 2001 $2,200,000 NA Average % spent in e-RA in 2001 2.6% 5.5% Expected increase in e-RA spend from 2001 to 2002 17.5% NA Expected % spend in 2004 NA 11.5%

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companies using e-RAs, the percent of total spend in percent of large firms and 25 to 30 percent of all 2001 was estimated to be about 5.5 percent. For all manufacturing firms using e-RAs. According to this companies combined, the percent of total spend through survey, small firms and non-manufacturing firms are less e-RAs in 2004 was expected to be about 11.5 percent. likely to use e-RAs.

As part of its ongoing benchmarking program, CAPS The difference between the number of firms reporting Research asked companies in eight industries about their using e-RAs in the CAPS Research and the ISM/Forrester use of e-RAs. Out of 81 responding companies, 42 surveys is probably due to the size of firms in the sample companies (52 percent) indicated that they were using populations. The CAPS Research respondents are all e-RAs in 2002. The average spend through e-RAs for Fortune 500 firms that actively participate in research these companies was 3.6 percent of total spend. The programs with CAPS Research. These firms tend to be median spend was 1.04 percent, indicating that some of first movers in the adoption of new technologies. The the companies were “power” users. Indeed, one firm largest firms in the ISM/Forrester report had purchases reported using e-RAs for 27 percent of its total spend. starting at $100 million, so they were smaller on average than the firms in the CAPS Research poll. ISM and Forrester Research started publishing a Report on eBusiness in January 2001. One of the questions in the These data lead to several conclusions. underlying survey asks if companies are using e-RAs. Figure 3 shows the results of this quarterly survey for the • The percentage of larger firms (over $100 million in past two years. (Unfortunately the survey does not ask spend) using e-RAs is at least 35 percent and about the extent of the usage.) probably over 50 percent. The percentage is lower for smaller firms and non-manufacturing firms. The results of this survey show that about 20 percent of all responding firms are using e-RAs, with 30 to 35

Figure 3 Companies’ Use of E-RAs

Did you purchase goods/services through an online auction over the Internet (percent “yes”)?

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• The average percent of spend going through e-RAs is A second limiting condition occurs in industries with still modest (less than 5 percent), but some firms are unusually high switching costs (e.g. pharmaceutical, due already using e-RAs for over 25 percent of their to regulatory requirements). Companies operating under spend. these conditions find the potential value of low bids for direct materials and packaging overwhelmed by the high • The growth rate in usage is strong (10 to 15 percent costs of qualifying new suppliers. increase per year). While most users expect that the solid cost savings produced by e-RAs may taper off, In contrast to the above examples, an electronics they also expect that the efficiency of e-RAs will company with short contract commitments (six to 12 continue to fuel the growth in use. months) and low switching costs estimated that up to 50 percent of its total spend could be conducted through e-RAs. Even in aviation and pharmaceutical companies, Experience across Industries significant portions of the spend for indirect goods could be purchased through e-RAs. (See Figure 4.) The use of e-RAs is not limited to a few or selected industries. The research team was able to find “power users” in the automotive, electronics, aviation, Experience across Commodity Types pharmaceutical, construction engineering, machinery, chemicals, and packaged goods industries. (The four case Initially, many firms conclude that e-RAs will find most studies presented later in this report are examples of application in purchasing indirect material and direct these “power users.”) Nonetheless, two different industry- materials that are commodities or near-commodities. The specific conditions can limit the use of e-RAs. First, in basis for this thinking is the belief that commodities and industries with unusually long-term supply contracts for indirect goods can be safely purchased largely on the direct material (e.g., aviation) the very terms of the basis of price. Furthermore, many companies initially contracts preclude putting material up for e-RA until the believe that e-RAs will not be a suitable way to source contracts expire. Because e-RAs are a relatively new with suppliers of direct materials and capital goods that buying tool, long-term contracts have limited the are used in critical applications, that have (apparently) a opportunity for buying direct materials through e-RAs. limited number of possible suppliers, or for which non- Furthermore, the long product development cycles in the price considerations have great importance. aviation industry and the need for suppliers to be deeply involved in the product development process may Upon reflection, and after some experience with e-RAs, continue to limit the use of e-RAs in this industry. most firms come to the conclusion that e-RAs can be

Figure 4 Applicability of E-RAs: Switching Costs vs. Length of Current Contract

APPLICABILITY OF REVERSE AUCTIONS

Low Long Contract Limited Agreements

Short Contract Agreements High Limited

Low Switching Costs High Switching Costs

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applied to many areas of their spend, including direct and indirect goods, capital goods, and services. The spring 2002 CAPS Research poll indicated that the majority of responding firms used e-RAs most often to buy direct goods. There are two compelling reasons for this change of direction. First, for manufacturing firms, the greatest portion of their spend is for direct material. If cost savings are to be achieved using e-RAs, it only makes sense to apply them where the most money is spent. Second, many indirect and commodity items have low value-add by the suppliers and are already priced with low margins. Therefore, the cost saving potential from e-RAs is limited for these buys.

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Sustainability of the Use of E-RAs

Sustainability of E-RAs As a Tool resulted in outcomes that were as good as its best negotiations and better than most of its negotiations. Are e-RAs here to stay or just another passing fad of the Therefore, e-RAs delivered best or near-best results in an digital economy? The skeptics relish the question, the efficient manner, even if the result was not a large cost early adopters scoff at the question, and the new adopters savings. are hopeful that they have chosen a winning tool. Fourth, e-RAs are becoming a desktop tool with a All of the evidence collected in this study suggests that commodity status. Many providers can provide the basic e-RAs are here to stay and that their use will continue functionality for e-RAs and can place it on the desktop of to grow. There are several facts to support this position. every buyer. Buyers can arrange e-RAs with minimal First, e-RAs have been shown to work — that is, produce effort and time. cost savings across a wide number of goods, services, industries, countries, and economic regions. While there Lastly, although not required, many companies are are cases of specific e-RAs failing, this research found integrating e-RAs into a more complex set of tools. These only one firm that had tried e-RAs and later abandoned tools encompass more of the sourcing process, their use. (Even this firm indicated they might try e-RAs particularly the RFx process. As this integration again at a future date.) Furthermore, this research found continues, buyers will have e-RAs available as a routine that the success of e-RAs had mostly overcome the early choice, along with sealed bids and traditional resistance and philosophical objections to their use. negotiations, to complete the buying process. Indeed, this research did not find any firms not using e-RAs because they objected to their use. The non-using On the other hand, no one quite knows what to expect firms either had not seen an application for them or had if the economy surges and tight supply markets develop. not gotten around to using them. Two possibilities exist. The first is that suppliers might organize forward auctions and sell their capacity to the Second, e-RAs are one of the few new e-tools that can be highest bidder. Many suppliers currently being coerced used in a stand-alone mode (although this may not be into e-RAs voice this as a veiled threat. But, it could the optimal deployment), without integration into ERP or prove to be an efficient means to clear markets, just other sourcing systems. This makes them relatively low- as e-RAs have been in a “buyer’s market.” cost to install and use. Many of the fees charged by third- party providers go to support the expertise that the A second possibility is that both buyers and suppliers will provider brings to the process, acting as a consultant in prefer to abandon e-RAs in favor of face-to-face terms of supplier identification or specification writing, negotiations. However, this return to the “old” way of for example. Thus, companies can reduce many of the doing business would sacrifice many of the efficiencies associated fees by using self-service auctions. gained by e-RAs. Companies may not be able or want to accommodate an increase in process inefficiency. Of Third, e-RAs are a very efficient method of getting to a course, it is unlikely that all supply markets will be tight final best price from a group of suppliers. Early uses of at the same time. As is true today, e-RAs are applicable e-RAs may result in substantial cost savings that are not only in certain circumstances. It seems unlikely that these sustainable later on. However, the efficiency remains circumstances will disappear altogether under any but the whatever the outcome. One company said that e-RAs most extreme economic conditions.

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Sustainability of E-RA Results Buying companies hope for this scenario but cannot be sure. Several suppliers, however, did identify this as their Long-term sustainability of e-RA results (i.e., substantial strategy. Participation in e-RAs would make them a better cost savings) is a question on the minds of most users supplier and would allow them to take business from and non-users alike. Logic alone suggests that buying their competitors in the future. This is a sustainable companies cannot expect to save, say 25 percent, on outcome, although even in this case, the decline in costs repeated buys for the same good and have the supplier, and bid prices will surely level out. or even supply base, stay in business. The companies in this study all suggested that they did not expect to maintain the same percentage of cost savings on Sustainability of Supplier Performance repeated buys. Nonetheless, several companies had experienced substantial cost savings on the second e-RA Sustainability of supplier performance is related to the for the same good. Longer term, most firms indicated above discussion, but has another important dimension. the savings will level off and become more driven by the Many suppliers have been quoted as saying that as they supply-demand conditions at the time of the e-RA. Thus, drop prices, they would not be able to sustain many of future results could be price increases rather than price the “free” services surrounding the goods they now decreases. provide to their customers. Design services, repair services, emergency delivers, and so forth would all In the current economy, several factors seem to be at disappear because the new low prices would not cover work to produce the price decreases currently enjoyed by the costs of providing these services. buying firms. The buyer response to these statements has been three- • Suppliers do not know or are ignoring their costs. fold. First, none of the buying companies in this study They get carried away in the “frenzy” of the e-RA and could identify a case where supplier service had submit bids for which they have no hope of making diminished after an e-RA that resulted in a new lower a profit. price. Thus, the buyers were skeptical of the claims. Second and more importantly, the buyers were interested • The economy is stagnating, and many supply in testing the value of the un-priced services. If the markets have excess capacity. Suppliers are services had value and were withheld, the buyers would submitting bids that are below total costs but, return to the suppliers and explicitly negotiate (or use hopefully, covering marginal costs. When the e-RA) for the services. economy turns around, the suppliers will submit bids that reflect total costs. Lastly, the experienced buying companies in this study were generally confident that they could include all of the The research team heard reports from buying firms and services they needed in the specifications for the e-RA. selling firms that results had been obtained in some cases This would not only allow suppliers to fairly price and due to these factors Both scenarios are non-sustainable in bid on the complete package of goods and related the long run. Suppliers must eventually cover their costs services, but also allow the buying firms to better know or go out of business. what they were paying for.

• Suppliers know their costs and margins and are Based on the evidence collected in this study, there is reducing their margins to gain or retain business. little or no evidence that e-RAs are driving all suppliers The net result may be more volume and profit, but into non-sustainable relationships with buyers. Actually, at a reduced margin. there is evidence to suggest the opposite. E-RAs are sharpening the relationships by removing some of the The research team heard from both buyers and suppliers ambiguity about market prices, forcing buyers to be that this is a frequent outcome. This seems to be a clearer about what they desire to buy (i.e., better bidding strategy for many incumbents, whose bids end specifications), and forcing suppliers to be clearer about up below their previous selling price. This strategy is what they are supplying. However, while it is clear that sustainable, although suppliers cannot indefinitely reduce buyers are enjoying the efficiency of e-RAs in getting to a their margins and stay in business. price, the efficiency gains on the supplier side are less visible. While there is scant evidence from this research • Suppliers work to lower their costs (following the that suppliers have been able to reduce sales costs or e-RA) in order to sustain their profit margins with personnel because of e-RAs, some sales managers the new lower selling prices. indicated that they now use their time differently. Prior to e-RAs they spent a lot of time in negotiations talking

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about price or cost elements. With e-RAs, they spend less time negotiating price face-to-face. This function is “delegated” to the e-RA. The face-to-face time is used more for discussions about creative, joint problem solving. However, this may be somewhat over-simplified. In former times, price discussions and creative problem solving were merged, while in this new approach, they are separated. The old model is still favored by the majority of the suppliers as it leaves more opportunity for creativity.

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E-RA Implementation Strategies

Implementing an e-RA initiative or process requires In addition, no relationship between a top-down versus a strategy on the part of both the buying firm and supplier bottom-up implementation approach and the occurrence firms. Also, training issues exist for both groups. of resistance within the purchasing function was observed. Over two-thirds of the buying organizations, regardless of implementation process, noted such Implementation of E-RAs in Buyer resistance from within their own departments. The most common means of overcoming this barrier was through Organizations e-RA education and training of buyers, obtaining the input of buyers in the development of the e-RA process, The interviews revealed that e-RAs can be implemented and by providing internal performance incentives, using either a top-down approach, in which the including making e-RA use and performance a part of the organization’s top management directs the use of e-RAs, buyer’s formal performance appraisal. or a bottom-up approach, in which the implementation originates from managers within the purchasing function. The majority of buying organizations also encountered For the buying organizations that were visited, the resistance to e-RAs from suppliers. One tactic used by implementation of e-RAs was almost evenly split between buying firms to overcome this issue was simply to leave a top-down and a bottom-up approach. In examining the suppliers no choice but to participate in e-RAs. As stated patterns between these approaches and barriers to e-RA by one buying firm, “There is much crying [by suppliers] implementation, it was observed that a top-down about reverse auctions, but that is just life.” More approach was not associated with resistance from any commonly used tactics to overcome the barrier of internal departments other than purchasing. Conversely, supplier resistance included communicating with and for firms that undertook a bottom-up approach, internal educating suppliers regarding the use of e-RAs. resistance was encountered in the marketing, information technology, and manufacturing (internal user) departments. Thus it appears that a top-down implementation approach to e-RAs is more effective than Implementation of E-RAs in Supplier a bottom-up approach in minimizing resistance from Organizations other functional areas in the organization. While technical difficulties can occur for buying firms, Unlike some past process changes that have involved the study found this to be a much more common unrealistically high management expectations, there was problem among suppliers. These technical barriers no consistent pattern across buying organizations included access issues and having a general regarding how realistic management expectations were at understanding of how the e-RA software works in a the beginning of the e-RA implementation process. Top rapid, real-time environment. One supplier’s computer management expectations, however, were unrealistically jammed the first time it participated in an e-RA, but the high for most companies, were realistic for some problem was rectified by not allowing others at the companies, were unrealistically low for a small number of supplier’s company to access the Internet during the e-RA firms, and some reported no expectations at all. event. Another supplier detailed the technological learning curve with the following comments.

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“The other challenge is understanding the actual put forth by the buyer in the RFx. This supplier software that [we are] using. The first time that a reported that buying organizations would agree to supplier navigates around the software package, it is allow it to participate under this scenario in about difficult to understand how to send a message and half the e-RA events. keep an eye on the bidding process at the same time.” The advantages realized from this supplier’s of the use of an COE e-RA team are significant. The e-RA team now Most suppliers overcome this hurdle simply by gaining has experience with over 60 e-RAs across 10 different hands-on experience with the software. Another strategy auction platforms. The supplier noted that this is to develop what the research team labels “centers of experience is key, as it takes a tremendous effort to excellence” (COE). These COEs can be created in both participate in e-RAs and to do them well: larger auctions the buyer and supplier organizations to facilitate have multiple-lot structures and are typically at multiple organizational learning and centralized e-RA knowledge locations that cross five or six sales regions. These and experience within a company. As an example of such complex events require substantial internal coordination. a COE, one supplier has created a COE reverse auction The e-RA team structure also allows the supplier to team that participates in customer e-RAs across all negotiate better e-RA terms and conditions, and provides divisions and geographical sales territories. Here is the the supplier with the structure and ability to walk away process it uses: from an e-RA if it is not in its best interest. In fact, this supplier has walked away from about half of the e-RA When this supplier receives an invitation to participate in invitations it has received. Finally, the supplier’s COE an e-RA, the event is first summarized along several e-RA provides increased discipline during the bidding characteristics including: process “because it’s really easy to get tied up into this bidding frenzy or get emotional — it’s a real emotional • the value of the opportunity thing.” This supplier always has a predetermined walk- • the risk regarding the stated terms and conditions away price and sticks to it. • the current risk that the supplier is already experiencing with this customer E-RA Training for Buyers and Suppliers Next, the supplier’s COE auction team identifies and distributes a detailed summary of the event to the key Training is a key enabler for the successful imple- players and decision-makers within its organization. mentation of e-RAs. This includes training of both Third, the supplier’s auction team conducts a participating suppliers and the buyers who conduct the teleconference with the key internal players to clarify e-RAs. Training is conducted by either the buying questions and issues regarding the e-RA. Finally, the organization or is outsourced to a e-RA service provider. business unit and auction team make a decision of Buyer training can be extensive. At one buying organiza- whether or not to participate, with the ultimate decision tion, over 300 individuals have each received over 13 being made by the business unit. This final decision can hours of training in the use of e-RAs. Above and beyond be to 1) participate unconditionally; 2) not participate; or the amount of time required for training, this company 3) participate with a “work-around.” noted that hands-on training yields better results than videoconference training. In the hands-on training There are two work-arounds that this supplier uses: sessions, the buying company’s staff can discuss the key attributes of a “mock” auction and run and rerun it under • If it is possible to insert comments into the software various scenarios. Such training has increased the bidding console, an e-RA team member will insert adoption rate of e-RAs and removed most of buyers’ boilerplate legal language that the supplier prefers to resistance to their use. use in its contracts. This boilerplate language states that “our bid is based on our terms and conditions.” Training for supplier participants is also important to • The second work-around is a letter that is sent to the achieve the successful use of e-RAs. While suppliers’ e-RA buyer (and event provider, if one is used) that states training generally is not as extensive as it is for buyers, that this supplier is interested in participating in the nonetheless, it is necessary to ensure that suppliers e-RA, but that there are certain terms and conditions thoroughly understand how to use the software and what of the RFx that the supplier cannot and will not it (and they) can and cannot do. Thus, it behooves buyer accept. The letter asks the buyer to allow the firms to take the time and make the effort to verify that supplier to participate, with the understanding that participating suppliers are adequately trained in both the the supplier’s participation does not mean that the use of the software and the rules in place for each e-RA supplier accepts the original terms and conditions event.

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Planning and Managing the E-RA Event

The E-RA Sourcing Decision Preparation for the E-RA Event

In every case study firm visited, the purchasing function From the interviews with buying firms, it became clear was involved in some way in the decision to conduct an that a well-planned (and often rehearsed by both buyers e-RA. In over half of these firms, purchasing had sole and participating suppliers) e-RA strategy developed prior discretion. For the remainder of the firms, the internal to the event is one of the most important predictors of customer and/or engineering were the two dominant event success. Firms reported that while more time and functional areas involved in the decision-making process. effort was required up front to develop these plans than The purchasing function was also responsible for for the traditional sourcing process, the speed of the preparing for the e-RA in all of the case study firms. As auction itself often made up for this extra time and effort. opposed to the decision-making process, the preparation In addition, as firms held more e-RAs, there was a for the e-RA tended to be more cross-functional in reported learning curve effect. Further, for each item nature. In the majority of these firms, engineering and/or being auctioned, some unique issues usually must be the internal customer also were involved with the considered and included in the auction’s plan. Some of preparation for the e-RA. these issues are:

The decision-making process in the buying organization • Ability to clearly define specifications that are stands in contrast to that in the supplier firms that were universally understood by the supply base, including interviewed. For the majority of these suppliers, the sales global suppliers. and marketing function had sole discretion for making • Identifying a sufficient number of qualified the decision to participate in e-RAs. However, only three competitors who are willing to participate in the of the 15 suppliers had declined to participate in any auction event. e-RAs. For the other firms, the corporate sales policy was • Potential impact on incumbent suppliers and plan to to always participate in e-RAs. It should be noted, offset possible negative consequences (e.g., supplier however, that participation by a supplier does not of a strategic item). guarantee to the buyer that the supplier will provide • Understanding the unique characteristics of the viable bids. Most suppliers felt pressured to participate in item’s supply market structure, degree of e-RAs, and some suppliers would react to this pressure competitiveness, key cost drivers, and current open by placing only nominal bids. As stated by one supplier: capacity (i.e., is it a buyers’, suppliers’, or neutral “If one should not want to participate, one keys in only market?). This information is essential for setting an one price and stops bidding or declares to the customer appropriately aggressive reserve price. that one had technical difficulties.” Finally, the marketing • Degree of experience of both the buyer and suppliers and sales functions were involved in the preparation of in participating in an e-RA event, including the e-RAs in all of the interviewed supplier firms. For the familiarity of the Web-based software being used. majority of these firms, the preparation process also • Event format; that is to say, what will be revealed involved engineering, and to a lesser extent, finance, during the e-RA for this particular group of suppliers accounting, and production. (price, rank, weighted price or rank, etc.); rules such as closing rule (e.g., hard close, soft close, rules for

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soft close); participation rules (bird-watching, offline majority of firms reported their teams were commodity- communications); and award rule (low price oriented and consisted of individuals from operations, guaranteed the business, post-negotiations, no award engineering, and supply management. Most teams also guarantee). included support from information systems if they did • Need to use a formal RFx (e-based or manual) for not use a third party e-RA provider onsite for the event. this particular event. Other firms interviewed, including pharmaceutical, electronics and aviation companies, included quality control engineers on their cross-functional commodity Observations from Interviews Regarding teams. When indirect goods and services were the target, the teams included appropriate internal stakeholders. Preparation When formal commodity teams existed, the team was responsible for deciding if an e-RA event was the correct Here are some specific observations, gleaned from the sourcing tool. If the commodity teams were more interviews, that relate to the development a buying firm’s informal, the commodity manager usually made the e-RA strategies for specific events. decision to use an e-RA.

• One of the most common supplier complaints An important precursor to holding an e-RA is to gain concerning e-RAs was the lack of a clear specifica- agreement between the commodity manager, the tions and rules from the buying firm. During an commodity team, and key internal stakeholders. They e-RA event (which can take from 10 minutes to 3 must agree on the components of the e-RA strategy, hours), there is not the time or mechanisms in e-RA including the format, rules, and suppliers invited to functionality to make on-the-fly clarifications. participate. If TCO is to be considered instead of lowest • One buying firm reported that its traditional price, then the components of TCO and their relative sourcing processes only achieved about 30 percent weights must be established and agreed upon. of the correct specification clarification before beginning face-to-face negotiation, while the remaining 70 percent was determined during the negotiation. Now, in preparing for an e-RA event, Buyer-Supplier Communication their specifications were about 90 percent correct. This process improvement, it reported, has carried One of the most important determinates of a well run over to all its sourcing activities. This suggests that e-RA is the development of a clear strategy for proper preparation for an e-RA can spill over to a communicating the purpose, rules, and award criteria general improvement in the strategic sourcing with both potential suppliers and qualified suppliers process. who are invited to participate in an e-RA event. One • The vast majority of companies interviewed believed commonly observed misconception communication that at least three qualified suppliers are required for among suppliers is that buying firms, by using an e-RA, a successful e-RA. are shifting from a TCO-award policy to a low-price • Several companies reported that they do not realize criterion. However, only one or two buying firms of those reduced cycle-times (the cycle of opportunity interviewed indicated they followed a strict “low price identification to award) when using an e-RA, because wins” strategy. The vast majority of buying firms tell the preparation time is increased. However, several bidders that TCO is the decision criteria, and low price others reported they did incur significant cycle-time will win the business only if all bidders are equal in all reductions as they became more experienced with non-price variables, and other conditions are met, such e-RA use, or re-bid a particular item. as the reserve price. In fact, as indicated earlier, less than • One company said conducting a successful e-RA is 50 percent of e-RAs are awarded to the low-price bidder, “75 percent preparation, 5 percent execution, and 20 and this is done only after TCO is either explicitly or percent fulfillment.” implicitly considered. Suppliers, on the other hand (with two exceptions) believed price was the most important criteria used in e-RA awards. One supplier stated that the buying firm had “changed their [sourcing] philosophy Role of Cross-Functional Teams in E-RAs from quality to low price.” However this buying firm actually was using a sophisticated, electronic TCO model Cross-functional teams are commonly used in sourcing to make award decisions. Whether withholding this organizations and have been considered good practice for information from the supplier was intentional (as part of many years. In designing and managing e-RAs, the use of the strategy) or an oversight was not clear. Another cross-functional teams becomes even more important supplier reported that it was waiting for the market to because of the increased preparation time required. The change from a buyers’ market to a suppliers’ market,

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hoping it can achieve enough market power to be able to any questions or misinterpretations that may arise during refuse to sell to this customer. Another supplier stated the event can be dealt with in a fashion that allows full that the use of e-RAs was leading its senior management transparency and minimizes the perception of ethical to re-think their relationship with the buying company. improprieties. Provider help desks are also often available The supplier was moving the buyer from a “collaboration to provide technical assistance and answer other supplier customer” category to a “transactional customer” category. questions. At one buying organization, there are separate On the other hand, this buying company firmly believed individuals assigned to each supplier during an e-RA, in their use of an e-RA with this supplier was improving order to assure that suppliers do not encounter busy their relationship and increasing collaboration among phone lines. Many software packages have built-in error them. checking. If a bidder reduces his or her bid by more than, for example 10 percent, the software will ask the What can buying firms do to eliminate this e-RA bidder if he or she really wants to submit this bid. To communication disconnect with their supply base? Here further help eliminate mistakes, some software will not are some “best practices” that were gleaned from the allow bidders to reduce their bid by more than, for interviews. example, 25 percent. These parameters can be set by the buying firm according to the situation surrounding the • Clearly communicate the award policy for each event. specific event held. Some may be low price, others may be TCO, and some may be “no award promised” and then award or pass accordingly. Role of RFxs in E-RAs • Provide timely and constructive feedback to both award winner(s) and losers. Over the long run, this The use of appropriate, well-written RFxs are key to will generate trust by the suppliers that the buying developing both clear specifications and qualified firm runs fair e-RAs. suppliers to participate in an e-RA. The three RFxs most • Train both buyers and suppliers in the use of the commonly used are: tools and do a mock test run so that both parties clearly understand the rules and how to interact with • Request for information (RFI): An RFI is designed to the software. obtain an overview of a supplier’s capabilities and • Warrant to the suppliers that no deceptive practices financial health. It may not be specific enough to (e.g., phantom bidders, allowing unqualified decide if the supplier is qualified to be invited to the suppliers to bid, accepting offline private bids) will e-RA event. This usually is the first “screen” through be tolerated, and that e-RAs are subject to the same which a potential supplier must pass to be strict ethical policies as other sourcing processes. considered qualified. • Request for proposal (RFP): An RFP asks a supplier to articulate how it would respond to a specific need. Buyer-Supplier Communication during an E-RA At one extreme, the RFP may only detail the end use Event or performance characteristics of the needed item or service and ask the supplier to propose specifically Ad hoc communication functionality (called messaging) how they would satisfy these needs. (e.g., office exists in most e-RA systems. This communication can be supplies) At the other extreme, an RFP may include a broadcast to all bidders or targeted to a specific bidder. detailed specifications and precise “build-to-print,” A broadcast message can inform all bidders of a common quality, and delivery requirements, and asks the issue that needs to be addressed (e. g., a mistake has supplier to propose how they would meet these been made by a specific bidder and the bid is being needs as stated, or by alternative means that would removed). A targeted messaging may be used to be more cost effective (e.g., highly engineered encourage bidding or to notify a bidder that the rules are component). not being followed (e.g., a supplier is not participating or • Request for quote (RFQ): Most specific of the RFxs, “bird watching”). These e-RA communication tools assist the RFQ asks the supplier to quote a price based in an orderly auction and add credibility to the auction upon detailed requirements, terms and conditions of process. delivery, quality, payment terms, warranty, and any other important specifications. This is where Most provider software packages allow either the buyer meticulous preparation is required by the buying or supplier to send these messages during the event. In firm to clearly specify requirements and by the most cases for those firms interviewed, these messages supplier to identify its costs, desired margins, and have full visibility among the bidding suppliers. Thus, open capacity should they be awarded the business.

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When used on the front end of an e-RA to identify both Test Runs, Contingency Planning, and Supplier potential and qualified suppliers, RFxs may be either Training e-based or non-e-based. From observing the firms in this study, there seems to be a trend toward using RFxs that Successful e-RAs are preceded by test runs of the software, are e-based and are integrated into the e-RA process, include the development of a specific contingency plan some with automatic analysis functionality. The e-RFx if systems go down, and include thorough training of may have the ability to perform complex, weighted total system use for both buyers and participating suppliers. cost of ownership measurements and/or optimize buyer The test run ensures that the appropriate technologies are “cherry picking” calculations. in place and that buyers and suppliers understand how the auction operates. Contingency planning establishes Which RFx or combination of RFxs (if any) is most and tests the backup protocol in case of technology appropriate for differently sourced goods and services, as failure. Supplier training entails running mock auctions categorized earlier in Figure 2? to familiarize the bidders and buyers with the auction technology and the nuances of the particular event. • Commodities (low purchase volume, low complexity): For a straightforward, price-oriented reverse auction After inviting suppliers to an e-RA, system testing is for non-direct, non-strategic standard (commodity) necessary to ensure the software and hardware will work items, where suppliers are well known (office supply flawlessly. This testing can be part of the service firms such as Staples, OfficeMax, Office Depot, or provider’s offering or performed by the buying company. Boise Cascade) it may be appropriate to not use an Because reverse auctions are Web-based, a browser and RFx. Suppliers can be invited, scope and an Internet connection are the minimum requirements to specifications communicated, and an auction held. access e-RA software. In complex auctions, with multiple Often these suppliers already have participated in lots or complex attribute bidding, DSL bandwidth is several e-RAs. On the other hand, the least specific often required. Backup is simply a dedicated telephone of the RFxs, the RFI, is probably adequate for this line if computer technology fails. The most common class of item. backup technique is for an impartial party to accept phone calls and place proxy bids for a company having • Leverage (high purchase volume, low complexity): technical problems. For this class of items, it depends upon a buying firm’s knowledge of the existing supply base. If it is In addition, a test of the contingency plan ensures the transparent, the use of an RFQ is most appropriate; ability for a bidder to continue bidding if technical if not, initial screening can be done with an RFI, problems arise. If a problem arises during an e-RA event, followed up by an RFQ for those suppliers that are using the e-RA communication functionality, the buying either clearly qualified or potentially qualified. company communicates to all bidders that a bidder is Generally, because of the low complexity of the having technical problems and proxy bids are being item, use of an RFP may not be useful. placed. • Bottleneck (low purchase volume, high complexity, It is important that bidders are thoroughly trained, but not strategic): Here, one might argue for the use comfortable with how bid entries occur, and knowl- of all three of the RFxs, in sequence. First, use a edgeable with the “look and feel” of the e-RA tools being streamlined RFI to identify only unknown potential used. Even if a bidder has used a buyer’s e-RA tools in suppliers, followed by an RFP to previously known the past, newly assigned individuals from the bidding and newly discovered potential suppliers to capture firms may not be familiar with the tool. The provider, in each proposal, and finally, for the short list of many instances, offers training for suppliers; however qualified suppliers, ask them to submit an RFQ. more and more buying firms are assuming this responsibility. Training usually includes a mock e-RA • Strategic (high purchase volume, high complexity): event that mirrors the planned event, showing the While any or all the RFxs can appropriately be used information that each bidder will see (price, rank, multi- for this category, few buying firms expose the attributes, virtual currency, e-messaging, etc.) as the event suppliers of these critical items to e-RAs. unfolds. Good-practice auction training uses a sample Nonetheless, each of the RFXs are useful tools to use auction that is similar to the actual event. in traditional negotiation processes. In fact, some firms were observed to be using sophisticated e-RFxs that did not run e-RAs.

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Non-Participation Rules e-RA may consist of multiple lots of single items and have different closing rules for how the e-RA will end. Each lot Several buyers interviewed had “bird watching,” or non- might be open for only 10 to 15 minutes or all the lots participation rules in place, which require a supplier to may be open for the entire duration of the e-RA event. place a minimum number of bids during an e-RA in Lots also can be structured toward global, regional, or order to continue to view the unfolding results of the local needs or in combination to enable award e-RA. Other buyers did not have such rules in place. The optimization. One company, using optimization tools, interpretation of these various responses regarding non- used this strategy regularly. participation rules is that if the buying organization believes that an e-RA will result in significantly lower Why is lotting an important e-RA strategy? By analyzing prices than were paid in the past, then the buying the market and the bidding suppliers’ capabilities, lots are organization probably does not want to include non- structured to increase cost reduction opportunities. The participation rules in the event. This lack of non- buying company can develop lot-bidding rules that participation rules then allows the other suppliers to requires all participants to bid on every lot, allow bidders see how low the price of the item has gone. Conversely, to only bid on the lots they can effectively supply, or even if buying organizations do not believe that prices will allow suppliers to structure their own lots, thus enabling go down significantly, then they probably do want to them to maximize their efficiencies. include non-participation rules. Buyers can review the TCO of the lots suppliers have constructed and see where supplier efficiencies can Lotting Strategies by Buying Firms improve TCO. Quantity discounts also can be part of the RFQ, giving suppliers the ability to reduce cost if awarded larger volumes of business. Lots can also be Lotting strategy is one important element in developing structured for global or regional aggregation and placed an e-RA strategy. It entails the buying firm developing a in the same e-RA. To decide what lotting strategy is best rational and appropriate market approach to it strategic for a specific e-RA, careful analysis is required. Provider’s sourcing process, taking into account what item or e-RA tools have different lotting capabilities, and some service is being sourced and the makeup of the supply may limit the variations available for use. market. These strategies fall into two main categories: market basket lots and individual lots.

A market basket lotting strategy is used when many items Closing Strategies in the same or similar commodity/purchase family group are bid and most, if not all, of the items can be sourced When developing a reverse auction strategy, choosing the from each bidder (e.g., plastic injection moldings). Often, closing strategy is important. A closing strategy is generally it is more effective to run an e-RA event for a family of defined as the rules for extending the time period(s) items, perhaps based upon an 80/20 Pareto analysis, than beyond the targeted closing time. However, this it is to bid each item. A market basket lotting strategy is definition is an oversimplification of the closing strategy. more effective if quantities are known and each item can An e-RA generally has some bidding activity at the be weighted according to projected usage. Most markets beginning, has some slowing in the middle, and rises to basket reverse auctions require bidders to submit bids in the highest activity level near the end of the scheduled an RFQ on all items; then, if a supplier receives the stop time. This often leads to a “bidding frenzy,” with award, the percentage reduction in its e-RA bid from the some bidders becoming unrational and submitting prices RFQ is used to calculate items not included in the e-RA. that are unprofitable. Suppliers interviewed regularly Several mature e-RA buyers regularly use the market observed this “bidding frenzy” behavior. The word basket on large-volume auctions. “crazy” was used by several suppliers. Thus, determining the best strategy to close an e-RA is dependant on both Individual lotting strategies have multiple variations, the buying and supplier firms’ auction maturity. The basic depending on the items to run through an e-RA, the closing strategies are: market, and the supply base. Lots consist of specific items. In a simple lot, only one item is bid (e.g., a highly • Set the auction time period and end it on time engineered part). Complex lots have multiple items and without any extensions. (Generally, a domestic the majority of lots have like items. If quantities are not auction is set to run from 30 minutes to one hour, known, the item is bid in a quantity of one. One while a global auction is set to run from one to two telecommunications company uses this lotting structure hours.) because its demand for the item is difficult to forecast. An • Establish a specific number of extensions if there is activity within the last two or three minutes. An

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example would be a maximum of three, five-minute The advantage of using an external provider is increased extensions if there is activity within the last two implementation speed and greater return on investment. minutes of the auction, or the first two extensions. The disadvantage of using a provider’s e-tools is the • Allow unlimited extensions, if there is activity with inability to purchase a complete suite of e-tools from any the last two minutes of the auction or any extension. one provider. No individual provider interviewed in mid- 2002 demonstrated a full suite of e-tools that covered the Other variations of closing strategies are: eight steps in the e-strategic sourcing process depicted in Figure 1 from Spend Analysis & Opportunity Assessment to • Only extend if the one of the lowest three bidders Follow up & Re-Sourcing. However, a few companies have has activity. internally developed e-tools complemented by a mix of • Have individual lots close at 10-minute intervals providers’ e-tools. For example, GlaxoSmithKline (see during a multi-lot auction. case study) has developed such a system that is quite • Keep all individual lots open for the entire duration advanced. of a during a multi-lot auction. • Close the auction early if the reserve or target price is not met.

When developing closing strategies, understanding supplier behavior is important. For instance, if a supplier knows most of the activity takes place in the last few minutes of the event, will it bid before then? If a supplier, through its bidding behavior, is able to send a signal the other bidders that it intends to win the business at no matter how low the lowest price, sophisticated suppliers will quit bidding early. For example, one supplier stated that it will drop out of an auction if it sees repeated bids of the minimum decrement plus a small amount. This, it felt, was a signal that this competitor was going to bid to obtain the business regardless of how low the price went.

Bid Commitment Duration

Bid commitment and duration rules are an important component of an e-RA strategy. However, the duration of the winning bidder’s commitment to deliver at a given price (and other terms and conditions) is market- and supplier-dependent. Generally, the reverse auction contract duration is no different from that of a traditional sourcing contract. However, because of the speed of dynamic e-negotiations, certain commodities, where the market changes quickly, may lend themselves to shorter commitment durations. If a qualified supply base is identified, and the market for a particular commodity/ purchase family group changes rapidly, e-RAs are an excellent tool to award business for short duration and re-auction regularly. For example, one company interviewed purchases highly engineered printed circuit boards quarterly through e-RAs.

E-Tool Suite Development

Who should develop a company’s e-tools? Several providers have developed or are developing e-RFx tools.

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Successful vs. Unsuccessful E-RA Events

As part of the study’s interview protocol, buyer firms submitted only one bid at the beginning of the e-RA. The participating in the study were asked to describe a pair of bid, which was far higher than the buyer’s maximum specific e-RA events. One of these events was one that (reserve) price, was still sufficiently low to stifle they considered to be “successful,” and one to be competitive bidding by the other four suppliers, and it “unsuccessful.” Here are some observed best practices of ultimately was the lowest bid. this component of the research

Size of the E-RA Event Defining Success The size of the e-RA, in terms of dollar volume, was With regard to a specific e-RA event, buyers interviewed significantly greater for observed successful e-RAs. The unanimously defined successful auctions as those that average dollar volume of the successful e-RAs identified exceeded the expected or perceived savings of a face-to- by buying organizations was over $45 million, compared face negotiation or traditional bid process, while to just over $1 million for the unsuccessful events. The unsuccessful auctions were those that did not exceed significant relationship between dollar volume and a these expectations. Given this definition, several distinct successful e-RA could be due to a greater emphasis differences between successful and unsuccessful e-RAs preparation by the buying firm, or the increased interest were observed. by and competition among suppliers, due to the greater dollar volume. Thus, one way to spur competition (and achieve a successful e-RA) among suppliers may be to Level of Competition increase the size of each e-RA’s spend.

The key success factor appears to be the level of competition that exists among suppliers. Typically, a large Supplier Visibility number of suppliers in an auction can be an indication of a competitive marketplace. That successful auctions Another means of increasing competition among generally included a greater number of suppliers than suppliers in e-RAs may be to use rank, rather than price, unsuccessful auctions could be due to the fact that the visibility. One buyer suggested that a “rank order keeps buyers could only find a limited number of suppliers to bidders active in an auction for a longer [period of] time.” invite to the unsuccessful e-RA. However, while an e-RA The observations made by the research team provide can theoretically be conducted with only two suppliers, some support for this statement, with unsuccessful all of the successful auctions discussed by buyers auctions involving price visibility and some successful involved four or more suppliers. What is perhaps more auctions utilizing only rank visibility. A rank-visible important though, is that most of the unsuccessful auction may also be advantageous when buyers want to auctions involved relatively uncompetitive supply minimize transparency, such as in the case of rising markets, and tended to result in a smaller number of markets or when the buyer intends to conduct further, uncompetitive bids from suppliers. For example, one traditional face-to-face negotiations. Here, the buyer reported unsuccessful e-RA included five suppliers, but simply needs to identify the best three suppliers based on only one competitive supplier. The competitive supplier bid price. There is no need to allow the low bidder to

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know how much lower its bid is compared to the second specificity: the buyer must be able to provide adequate lowest bidder. specifications in order to conduct a successful e-RA. While this report is not suggesting that specificity is the As a final example of the transparency-minimizing sole criterion for a successful e-RA, one case study advantages of a rank-visible auction, one German buying participant suggested enthusiastically, “If you can spec it, organization conducted a price-visible e-RA that, while you can bid it!” successful in the short-run, will likely lead to large price increases in the future. The sixth bid in this auction was submitted by a low-cost supplier at a price that was 40 Switching Costs percent below the prior bid. No additional bids were submitted during the event. When this buying Another important facet of the e-RA that relates to the organization conducts its next auction with this supplier, auction environment is the degree of switching costs that the supplier will know that its price is 40 percent lower a buyer would incur by choosing a new supplier. Several than the competition and will likely raise its price by a buyers suggested that low switching costs are an significant amount. important — if not necessary — prerequisite to conducting a successful e-RA. Spend items with high switching costs, such as those that involve unique Lotting Strategies suppliers, asset specificity, or a high degree of past buyer- supplier collaboration, were viewed by many as being The findings provide stronger support for using multiple unsuitable for an e-RA, and its use would result in an lots than a single lot in an e-RA. In the firms for which unsuccessful event in the long run. Conversely, one buyer this variable was captured, the successful e-RA involved suggested that if he held an auction and a new, untested multiple lots, while the unsuccessful event consisted of supplier was the most competitive, the buyer would only a single lot. This finding could be a facet of the retain the contract with the old supplier, but would begin larger size of successful events, or it may be due to the to qualify the new supplier if the potential cost savings complexity of a multi-lot event that requires suppliers to were enough to cover testing and qualifying costs. focus on many decisions simultaneously, perhaps making them less efficient in the bidding process. In some industries, such as pharmaceuticals and aerospace, switching costs are high, while in others, such as some high technology industries that use commodity- Item Specificity and Complexity like inputs, the switching costs can be minimal. However, regardless of the industry, the interviews revealed that Complexity can be considered along three dimensions: most buying firms were not capturing the dollar value of these switching costs. Thus, it is suggested that e-RA 1) technical complexity — the manner in which users should quantify the cost of switching suppliers and different parts interact with each other in a system use this information either within a multi-attribute e-RA 2) commercial complexity — the presence of price and or as one of the decision criteria that is combined with exchange rate fluctuations the bid from a price-based e-RA. 3) logistical complexity — the location (e.g., China) of the competitive supply base. Supplier Success and Change Costs In the case of technical complexity, the purchased item is often critical to the function of the final product and may On the supplier side, incumbents usually are aware that be difficult to produce. Commercial complexity can they do not have to be the low bidder in order to win include not only fluctuations in commodity prices and business. For example, one supplier noted that one of the currencies, but also differing payment schedules (e.g., significant challenges of e-RAs is to try to find out what percent net and annual rebates) and clauses for evergreen the acceptable price level is for customers, because contracts. Finally, logistical complexity can encompass customers are not choosing the lowest price. Thus, the the use of multiple transportation modes for a move, challenge for this supplier is in identifying the threshold multiple receiving plants and facilities, and JIT price that will win the supplier the business, without requirements. bidding any lower than that threshold price. This statement shows that e-RA strategy is evolving, not only While increasing the difficulty of the sourcing process, on the buyer, but also on the supplier side, as both these complexities do not preclude the successful use become more experienced with e-RAs. of e-RAs. Instead, the key aspect of e-RAs is that of

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The Auction Experience of Buyers and positive, effect on their relationships with customers. This Suppliers broad feeling of deterioration in customer relationships is likely based on several, more specific outcomes discussed by suppliers. First, three suppliers indicated that the level Interestingly, the researchers did not find a pattern of trust they had in customers had decreased, and no relating prior e-RA experience of the buyers and auction suppliers indicated an increase in trust. Similarly, success. Similarly, when buyers were asked to describe commitment levels to customers appear to have successful and unsuccessful e-RAs, no indication was decreased. Finally, 80 percent of suppliers noted lower found that the unsuccessful e-RAs that they described sales prices as a result of e-RAs. The remaining 20 were some of the earlier or initial e-RAs conducted by the percent indicated no change in sales prices. firm. Thus, there is not necessarily a link between the auction experience of buyers and auction success, in that Several suppliers stated that one common response has both successful and unsuccessful e-RAs seem to occur been, or will be, to provide fewer services and less throughout the adoption process of buying organizations. dedication to customers that employ e-RAs. This “price- However, it is important to note that this finding may only” sales strategy may also involve an unwillingness to very well be a facet of buyers “picking the low-hanging provide e-RA customers with additional capacity when fruit” for initial e-RAs. If that’s the case, buyers should be overall demand increases: cautious when testing the boundaries of e-RAs, understanding that as they evolve and use e-RAs to a “I’m afraid that companies that solely rely on e-RAs greater extent, the low-hanging savings have already been for their normal way of conducting business might captured. On the other hand, buyers should be aware be left out in the cold. We don’t want to lose that the outcomes of moving down the learning curve customers like this, but they’re the ones who have include not only price (or TCO) savings, but other made their own bed.” valuable benefits such as decreased cycle-times and other process improvements.

Several of the interviewed suppliers felt that they were at a disadvantage during their first few e-RAs because they did not understand the e-RA process in general and the software in particular. Thus, even though these suppliers had gone through some sort of training, the suppliers did not know what to expect during the actual event. One supplier said, “the participation in test runs does not necessarily help as the test auction and the real thing are not necessarily designed or conducted in the same way.” Further, many suppliers had no real strategy when entering the auction. For example, one supplier bid its lowest (best) price at the very beginning of the event, without any clear tactical or strategic intent in doing so, and several others had not even established the lowest price that they were willing to submit during the auction.

Buyer-Supplier Relationships

Researchers observed a 2-to-1 ratio of buyers who felt that e-RAs improve, as opposed to harm, their supplier relationships. The buyers who felt that relationships had been improved cited increased levels of trust, greater access to supplier data, and a greater amount of business for suppliers in the case of aggregation auctions. Higher level of trust might be engendered due to the transparency and objectivity of the auction process.

Perhaps not surprisingly, the vast majority of suppliers felt that e-RAs have had a negative, as opposed to a

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Emerging Issues

The emergence of and growing use of e-RAs has sourcing strategy. (This does not preclude e-RA use in generated several issues that deserve discussion. finding a new supplier for a strategic item through an initial e-RA, especially if the current strategic supplier is no longer economically or technically competitive.) Will Repeat Buys Deliver Value? Thus, referring to Figure 2, repeat buys are most likely to be cost effective for commodities and leverage items Are e-RAs effective for repeat buys of the same items, or (less complex categories), and not so for strategic and is there diminishing marginal returns (savings) after the bottleneck items (more complex). However, as stated first or second repeated buys? Since the tool is in its early above, this research was not able to verify this hypothesis adoption stage, the vast majority of e-RA-sourced items due to the relative infancy of the use of e-RAs. are not repeat buys, and, therefore, a definitive answer has not been determined by this research. However, the few companies that have performed repeat buys have Will Smaller or Larger Supplier Bases reported successive cost reductions, albeit generally Develop? smaller than those obtained through the initial event. Rationalized supplier bases have been considered to be a Repeat buys are common for items with regularly best-sourcing practice for many years. While “rationaliza- changing markets such as perishables, construction tion” generally means supply base reduction, it also services and printed circuit boards. One buyer considered means an increase in a supply base where not enough e-RAs to be an effective method to determine market competition exists. price in an expanding or contacting economy. This company performs repeated e-RAs with its suppliers to The e-RA tool (along with complementary tools such as ensure it is getting the best market pricing. For example, e-RFxs) has the unique ability to help a firm rationalize an electronics company is performing regular repeat buys its supply base in both directions. First, it allows a for printed circuit boards and envisions the use e-RAs for company to exponentially expand its geographical 50 percent of its direct spend. supplier reach and simultaneously negotiate with a larger number of suppliers. On the reduction side, the tools aid On the supplier side, a manufacturer of printed circuit in the ability of the buying firm to aggregate demand and boards has participated in semiannual and annual e-RAs offer larger consolidated buys to a few large-capacity for the same items and anticipates that about 20 percent suppliers who can translate economies of scale into lower of their 2003 sales will be via e-RAs. prices. The issue here is: will these e-sourcing tools lead to an increase in qualified competitors (both large and A company’s strategy for sourcing an item or family of small) through their global reach, or result in a items is important in determining the potential value of concentration of market power in a handful of large repeat buys. That is, will the savings generated from a competitors when buying firms aggregate and standardize repeated buy exceed the cost of holding the event? If the more and more of their spend? buying firm’s strategy is aggregation and the development of a collaborative supply base for strategic items, repeat buys through e-RAs are generally not an effective ongoing

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Do E-RAs Result in a Shift in Power from to higher value-added activities. The “best negotiators” Suppliers to Buyers? can be deployed to negotiate strategic activities, adding even greater value. In addition, many post-e-RAs include further negotiation sessions with the winning bidder, and Are e-RAs affecting suppliers’ market advantage? the issues discussed usually require more knowledge and Potentially, a supplier has a market knowledge advantage skill than price determination. From the interviews, those over the buying organization, because it specializes in companies that plan to source 50 percent of their spend limited product or service markets while a buying through e-RAs require strategic negotiations for the other company only has limited knowledge of the markets for a 50 percent. Negotiation skill may even improve over time broad range of the things it buys. Gold, for example, has due the extensive up-front preparation required for a world price that is constantly updated, thus equalizing effective e-RAs. market knowledge between buyers and suppliers. However, few goods (except for those traded on organized exchanges) or services have exact, known market prices. What is Happening to the Development of E-RA Functionalities from Providers? On the other hand, a well-conducted e-RA shifts the advantage from the supplier to the buyer because the E-RA functionality has become a commodity. Providers buyer is passive during the event. That is, the dynamic are rapidly attempting to differentiate themselves from nature of an e-RA demands that the bidders determine a their competitors, and users are requesting robust and microcosm of “today’s market price,” at least between the dynamic e-functionality. One provider says that potential bidders and the buyer, when qualified suppliers place customers are looking for “holistic” e-functionality. As a real-time bids. Observing an e-RA clearly demonstrates result, it is expected that e-sourcing functionality this shift in power. During an auction, the buyers development will improve and integrate spend/ passively observe bidding activity while competing opportunity analysis, TCO analysis, robust e-RFxs, suppliers are busy setting the market price, which is optimization, and performance measurement. usually lower than they would charge if so much focus was not on price alone. However, in mid-2002, no single provider has developed a fully integrated suite of e-tools; few buying companies The key question is: because this study was conducted in have even defined their e-RA requirements. For the e-RA 2002, when the world economy was in a severe tool itself, several providers have developed and deployed economic slowdown and many suppliers faced a strong do-it-yourself systems that have been used successfully buyers’ market, will this perceived shift in power prevail and at much lower cost than if run by a provider. when the economy rebounds? Or, will suppliers who have taken reduced margins refuse to participate in some or all e-RAs proposed by their customers? Are Dynamic E-TCO Tools Available?

Many suppliers dislike participating in e-RAs because What Effects Will E-RAs Have upon they perceive them as purely low price oriented. Negotiation Skills? Generally, early e-RAs were price-oriented, and many still are. However, buying companies are striving to make There is ample evidence that well-run e-RAs achieve rational TCO decisions in awarding business. Today, both results equal to or better than a company’s best objective and subjective attribute weighting models, as negotiators, with significantly reduced negotiation cycle- well as other traditional methods, are used to measure times. Two companies reported that after completing cost, quality, delivery, and productivity. However, how company-wide traditional negotiations for their spend, one designs and implements a dynamic e-TCO (one that they are seeing an additional 15 percent average cost is dynamically updated in real-time) remains a challenge. reduction through their e-RA programs. Another Some providers have developed e-TCO functionality, but company reported that it is achieving e-RA savings that adoption to date is limited. Further development is on are 10 percent better than its best negotiator. everybody’s “to do” list, but the current economy has precluded much of the development of this e-tool. At Thus, the question is: over time, will buyers’ negotiations present, most TCO criteria will be considered in a static skills diminish because e-RAs are simply online, sense, that is, after the e-RA event is over, when non- automated negotiation sessions? The answer clearly is no. price variables are taken into account. Companies using e-RAs are deploying sourcing personnel

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Will the Importance of E-RFxs Increase?

The answer to the above question is a firm yes. E-RFx tools offer the ability to expand buyer/supplier activities. An integrated e-RFx is a platform for both internal and external collaboration, reducing preparation cycle-times while improving the quality of proposals and quotes from suppliers. The e-RFx family of e-tools enables an organization to move all sourcing activities to e-status, not just reverse auctions. Dynamic information sharing from e-RFxs can qualify new suppliers, transfer complex drawings and specifications, obtain internal and external experts’ input, modify proposals, and compare responses from potential suppliers. This class of e-sourcing tools will prevail with or without e-RAs.

Do Global Obstacles Limit the Use of E-RAs?

High quality, low-cost suppliers exist throughout Europe, Asia, South America, and India. However, available tools, in the past, have limited the ability to fully exploit global supply strategies. Addressing language differences, time zones, exchange rates of currency, and culture is required before a successful global e-RA event can be held. Fortunately, most e-RA systems have been deployed worldwide by both service providers and buying companies. Thus, the reach of e-RAs has increased both the opportunity and the feasibility for holding global sourcing events, and it is predicted that these low-cost, high quality markets have barely been touched.

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Non-User Observations and Issues

One component of this study included interviews of contracts in place that would not expire for a few years, some buying firms that had never been involved in an or e-RAs would not be appropriate for their key e-RA, or had used them in the past, but chose to “strategic” suppliers. Further, one respondent indicated discontinue their use. The following observations they were so highly decentralized that they would find it and issues emerged from the firms interviewed. difficult the get enough aggregate demand to make e-RAs cost effective. Also, a few interviewees expressed concern that their suppliers may not participate, or not enough Reasons for Non-Use qualified competitors would join the e-RA event. Some minor resistance from internal clients and top The vast majority of the organizations interviewed had management was voiced, but this was not a major firm plans to begin using e-RAs in the near future. Only deterrent to e-RA use. When asked if they were one of the firms interviewed had used an e-RA tool in the concerned about the fairness of e-RA processes, a few past and discontinued its use because the savings were no rumored anecdotal stories about phantom bidders, but better than their traditional sourcing methods. However, generally, the respondents were not concerned. In fact, even this firm indicated they planned to return to e-RA some of the non-using firms asked the interviewers to use in the near future in areas where it felt there were give examples of what was meant by “unethical practices” more opportunities for positive results. Interestingly, none with e-RA use. Finally, there was some concern about the of the firms had any major philosophical or ethical nature of the e-RA systems’ range of capabilities and their objections to e-RA use for sourcing certain targeted (i.e., ease of use. However, this too was not a major issue. non-strategic) commodities.

When asked why they were only now planning to use Conclusions Regarding Non-Users e-RAs, here are the reasons the firms gave. In summary, this component of the study did not reveal First, interviewees all were aware of the general nature any serious barriers to the use of e-RAs. In fact, it seems of e-RAs, but some had higher priorities and limited from these findings that many firms who have taken a resources to devote to their use. In addition, some firms “wait-and-see” strategy now believe they could be at a had received proposals from third-party e-RA service serious disadvantage unless they add e-RA tools to their providers with fees they thought were too high when sourcing strategies. compared to expected benefits. However, recent publicity about e-RA value had changed their minds, and some were planning pilots.

Next, one firm believed their current traditional RFx process, coupled with its face-to-face negotiation strategy was delivering satisfactory results, and it felt it couldn’t do any better with e-RAs. A small number reported that only a few of their procured items were suitable for e-RA application, primarily because they had several long-term

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Ethical Issues Related to E-RA Use

Observed Ethical Issues • “[There is] no more hiding bad performance of the buyer, and no more lying to the supplier.” Some of the potential ethical issues surrounding e-RAs, as described by informants, are briefly defined in Table 2. • “[E-RAs] eliminate cronyism, just as does job There were differernt perceptions of ethical behavior rotation and giving buyers new materials groups within the buyer group and within the supplier group, as every three years. [E-RAs] eliminate cronyism well as between the buyers and suppliers. Some buyer without having to put buyers through frequent organizations, while addressing at least some of the learning curves.” ethical issues shown in Table 2, stated that e-RAs are no different from traditional negotiations with regard to As suggested by this last statement, e-RAs might even act ethical improprieties. Another group of buying as a substitute for job rotation in terms of eliminating organizations stated that e-RAs actually improved the cronyism, while minimizing the disruptive disadvantages state of ethics and fairness by making the sourcing associated with job rotation. process more objective (e.g., through the elimination of cronyism and supplier “wining and dining”) and more Several suppliers interviewed echoed sentiments similar transparent, as suggested by the following statements to those of their buyer counterparts regarding a lack of from purchasing managers: change in any ethical issues after the introduction of e-RAs. Counter to some of the recent assertions found in • “Now all suppliers get the same information at the the trade press, some of these suppliers also stated that same time – this increases fairness.” e-RAs were a fairer process of awarding business, indicating that e-RAs helped to “level the playing field” • “[E-RAs] change the ‘old boy network’ of sourcing.” through increased transparency.

Table 2 Ethical Issues Surrounding Reverse Auctions

Buyers using e-RAs can force suppliers out of business by accepting what they know to be unreasonably low prices. Buyer pretends to be a supplier in the e-RA event and bids low to force down price. Buyer includes suppliers in e-RA who are not pre-qualified and probably not viable. Suppliers engage in collusion. Supplier bids unrealistically low price. After winning the business based on low price, the supplier then recoups profit by charging for change orders. Suppliers “participating” in an auction but not bidding, with goal of gaining market intelligence. Supplier cannot deliver product/service as promised. After the e-RA event is closed, another supplier meets or beats the low bid and is awarded business, based on either buyer’s or supplier’s initiative. Low prices “forced” some suppliers to cut corners in the safety arena.

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Potential vs. Actual Unethical Practices to ensure that they are familiar with the software and event rules, as well as training buyers to ensure that they The same sets of potential ethical issues that were understand both the mechanics of the event and mentioned by buyers (described in Table 2) were also appropriate behavior and communication surrounding discussed by suppliers. One important difference, the event. however, is that while buyers might mention a particular ethical transgression in which their firm could be Perhaps an even more powerful avoidance mechanism to involved, but actually was not, suppliers often mentioned unethical behavior is the fear of damaging the reputation the same ethical issue with the thought that buyers might of a firm or an individual. At the company level, actually be guilty of that transgression. One common organizations suggested that, “Our reputation is example mentioned by suppliers was that of buying firms key…therefore this [unethical activity] is out of the that submitted “phantom” bids during an e-RA in order question,” and that, “As soon as you mislead suppliers, to artificially increase competition. While buying they will discuss this with their association, word gets organizations mentioned this as a potential ethical issue, out, and you [the buyer] lose your credibility.” Further, they provided numerous examples of how this unethical there is a similar avoidance mechanism at the individual behavior could not occur within their organizations, due level, as suggested by another purchasing manager: “If a to the existence of safeguarding mechanisms within the sourcing employee engaged in any unethical behavior, provider software and/or the presence of multiple buyers such as fake proxy bidding, they would lose their job.” and even personnel from another function during the e-RA. Nonetheless, some suppliers were not entirely convinced that phantom bidding was not actually Ethical Issues Unique to E-RAs occurring. Other suppliers indicated that they had these suspicions during their early experiences with e-RAs, but On the buyer side, phantom bidding by buyers was the that their concerns had been assuaged after buyers had unethical behavior most commonly mentioned by both explained the safeguards that were in place to prevent buyers and suppliers. As mentioned above, several phantom bidding. An example of a supplier transgression suppliers had at least some suspicions that their is that of collusion before or during an e-RA. While no customers were engaged in this activity, even when supplier admitted to collusion, a few of the buying customer assurances were provided. Other buyer companies indicated that they had suspicions regarding a activities that were viewed as being unethical include few of their suppliers. using unqualified suppliers in the e-RA in order to stimulate competition, and using an e-RA to simply These examples lead to two important points. First, there benchmark price with no intention of awarding the are some differing perceptions between buyers and business. suppliers regarding the involvement of each group in unethical activities. As has been shown in earlier ethics Due to the transparency of e-RAs, a supplier can research, such differences in perceptions can damage the determine whether or not it submitted the lowest bid buyer-supplier relationship. In fact, perceptions of ethical price (or tied with other low-price bidders) during an improprieties can be just as damaging as actual ethical e-RA, even if only bid ranks are shown. Thus, a transgressions. Second, the researchers identified effective corresponding supplier activity that was considered to be ways buyers and suppliers counteract these unethical is providing unrealistically low bids (below misperceptions. variable costs) in order to win an e-RA, followed by high change order charges in order to recoup profits. Another possible consequence of an unrealistically low bid by a Avoiding Actual or Perceived Unethical supplier is a request by the supplier to submit a higher, Practices more realistic bid after the auction, with the excuse (either true or untrue) that it made a mistake in calculating its costs. Buying companies indicated that Both buyers and suppliers stated that one effective means they would generally not hold a supplier to an of avoiding, or at least lessening, ethical misperceptions is unrealistically low bid, but would also not allow that to clearly explain and communicate to the other party the supplier to re-bid outside of the e-RA. The award goes to event rules and conditions and other details of the e-RA. the next bidder. Finally, “bird watching,” the process of Or, as was stated by one buyer when asked how ethical viewing, but not seriously participating in an e-RA, with misperceptions could be avoided, “You need to explain the goal of gaining market intelligence, was viewed by what you are going to do, then walk your talk.” Another some buyers and suppliers as unethical, while other observed way of avoiding ethical improprieties is buyers and suppliers viewed this simply as a thorough training. This can include training of suppliers consequence of participating in or hosting e-RAs.

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Finally, note that many of the above activities have been discussed within newly emerging codes of conduct developed for e-RAs within specific industries, such as the Original Equipment Suppliers Association (OESA) of North America, www.oesa.org/pdf/Conduct.pdf, and the European Aluminum Foil Association (EAFA), www.alufoil.org/pdf/eCommerce.pdf. While the activities discussed here are even more encompassing than those included within the codes of conduct of associations, they nonetheless show a growing recognition of the need to provide assurances that strict ethical behaviors are practiced by both buyers and suppliers involved in e-RA sourcing.

Finally, the observations from this research do not allow speculation as to the prevalence of the identified unethical behaviors, nor do the researchers make normative judgments regarding the ethicality or unethicality of these activities. Rather, these are real or perceived behaviors that were mentioned by informants when asked about ethical issues surrounding their use of e-RAs.

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Conclusions

Based on this research, the following conclusions can be reached:

• Reported payback usually can be achieved after the first few uses of the e-RA tool.

• There is little or no evidence that e-RAs are driving a significant number of suppliers into non-sustainable relationships with buyers.

• Firms who have taken a “wait-and-see” strategy indicated that they could be at a serious competitive disadvantage unless they add e-RA tools to their mix of sourcing strategies.

• E-RAs are here to stay and that their use will continue to grow.

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Case Studies

The following four case studies of “super users” of e-RAs • respiratory were chosen to provide some specific examples of these • gastro-intestinal/metabolics firms’ use of this tool: In addition, GSK is a leader in vaccines and has growing • GlaxoSmithKline (global pharmaceutical company) portfolios of oncology products, non-prescription drugs, oral care products, and nutritional drinks. • Bechtel (one of the world’s largest engineering- construction firms) In 2001, GSK had sales of almost $30 billion from 140 countries and profits (before taxes) of almost $9 billion. • Volkswagen Group (Audi, Bentley/Rolls Royce, Pharmaceutical sales accounted for $25 billion, with 22 Bugatti, Lamborghini, Seat, Skoda, VW, and VW percent of these sales coming from new products. Annual Commercial Vehicles) external spend is about $10 billion, with $7 billion for indirect goods and services and $3 billion for direct • METRO group (major European food, hard, and soft production goods. Currently, GSK has an aggressive goal goods retailer) of taking $1.5 billion (15 percent) out of its annual spend. It expects a good proportion of these savings to come from the estimated $1 billion of its spend it plans GlaxoSmithKline to run through e-RAs in 2003.

Company Background Management’s Expectations of E-RAs GlaxoSmithKline (GSK) (www.gsk.com) is a leading GSK began experimenting with e-RAs in 1999. During global pharmaceutical company with a strong mix of this experimentation, the firm’s top management as well skills and resources that provides a platform for as their procurement professionals, were pessimistic delivering exceptional growth in today’s rapidly changing about the value of e-RAs. However, by 2002, both groups healthcare environment. had a dramatic about-face, and strongly believe in the value of the use of e-RAs in conjunction with e-RFX GSK’s mission is to improve the quality of human life by tools. (See Figure 5.) enabling people to be more active, feel better, and live longer. How GSK Defines E-RAs GSK has a formal strategic sourcing process to select the Headquartered in the United Kingdom, the company is appropriate sourcing strategy or tactic for various the result of mergers of GlaxoWellcome and SmithKline commodity families. However, they believe that the use Beechem. GSK has an estimated 7 percent share of the of e-RAs is a major and integral strategic tool for their world’s pharmaceutical market, and its products focus on “Sourcing Group Management Process.” (See Figure 6.) four major therapeutic areas: GSK’s E-Sourcing Tools • anti-infectives GSK is particularly proud of its e-sourcing platform TM • central nervous system (GalaXy ) which combines decision support tools with

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Figure 5 GSK Management’s Changing Expectations of E-RAs

Top Management’s expectations …

Senior GSK Management Procurement Management 1999 1999 • didn’t understand • questioned value • questioned value • feared supplier reaction • feared job security 2002 2002 • values as a strategic • views as a “must have” Procurement tool tool • believes 40 to 50% of • understands operational spend can be auctioned efficiency potential (80% can be RFX) • eRFX driving re-org

state-of-the-art RFx capabilities. (See Figure 7.) They strategies and tactics for each commodity family. (See have created an e-sourcing portal (GalaXyTM) that houses Figure 8.) GSK has three main requirements for a the “TrakTM” systems and e-RFX software (Emptoris category to be “auctionable”: ePASSTM). Included in this online systems portfolio are: • Does the category lend itself to negotiation? • SpendTrakTM (122 data feeds from 59 countries) for • Are there three or more suppliers who are willing to spend data management participate? • ConTrakTM for contract development and • Can specifications and customer requirements be management clearly documented prior to event? • SourceTrakTM for maintaining supply base information and management of sourcing strategies Table 3 shows the broad array of “auctionable items” that • SaveTrakTM for validation, management, and GSK has sourced through e-RAs. reporting of all savings projects • ChangeTrakTM which analyzes the impact of material GSK’s Use and Results of E-RAs changes in the direct material area • GSK has held about 190 e-RA events between 1999 • PlanTrakTM for determining annual material standards and 2002, accounting for $912 million in spend. • CapExTrakTM which aids in the management of • There were events were held in 2001 (28 with a capital projects third-party service provider; 17, self-service). • There were 90 events held in 2002 YTD (20 This suite of decision support tools is complemented by with service provider; 70 self-service). (Clearly, Emptoris ePASSTM RFx functionality that supports e-RAs, they are shifting from a full-service to a requests for information, sealed bids, and sourcing self-service delivery of e-RA events.) optimization. • GSK has used FreeMarkets as its service provider. How Does GSK Decide to Use an e-RA and What • Savings realized over historical prices to date is is “Auctionable”? $165 million (18 percent).

GlaxoSmithKline uses the classical 2 x 2 risk-versus- • The vast majority of e-RA events are based on price spend value matrix to determine the appropriate sourcing only, however GSK is beginning to experiment with

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Figure 6 GSK’s Definition of E-RAs

GSK’s definition of “eRA”? Where it starts and where it ends?

The Way We Work… • The Sourcing Group Sourcing Grouup Management Process Management Process is the foundation of GSKs Strategic Sourcing… Strategy Process Situation Creation Strategy Initiation Analysis & Approval Implementation • eRA is an integral part of GSKs Sourcing Group Management Process…

Continuous Improvement • eRA starts at the beginning of the SGM

Supplier Management Supply Management Specification Management process and follows the process trough implementation…

multi-variable bidding so decisions can be based on GSK’s General Rules for E-RA Events TCO. In general, bidders only see the ranking of their price during an event. Bidders: • Bids are legally valid quotations without • Reported cycle-time savings: qualification. No bids can be withdrawn except for • Overall savings from RFx-to-contract award data entry errors. largely is unchanged. • Bids are only accepted for complete lots. No partial • However, “negotiation” cycle-time, on average, bids permitted. has been cut in half. • Bids can only be submitted through the online bidding mechanism supplied by service provider. No • GSK plans to use e-RAs about $1 billion of spend in bids may be submitted via any other mechanism, 2003, and has a goal of running 80 percent of its including but not limited to e-mail, fax, verbal, post, annual spend through a combination of e-RA and or courier, unless specifically requested by GSK or e-RFx sourcing tools. service provider.

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Figure 7 GSK’s E-Sourcing Tools

Figure 8 GSK Sourcing Tool Matrix

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Table 3 provider judges that any participant has been Items GSK Sources Via E-RAs disadvantaged by a problem, the service provider will correct the problem and may return the lot to Aluminium Tubes open status. Caffeine • Bidder is party to Participant Agreement which Capsules protects the confidential information of GSK and Chromatography Consumables service provider. Citric Acid Corn Derivatives (Sweeteners) GSK: Corrugated Packaging • GSK will approve each bidder invited to participate Desktops/Laptops in the e-RA event. Document Management • GSK intends to award business only to participating Electricity bidders and to neither negotiate with nor award to Elevators non-participants. Fire Prevention Systems • GSK may consider multiple criteria in addition to Firewalls price to determine the final award. Glass Bottles • GSK may set a bona fide reserve price for each lot, Global Car Hire representing the price at which GSK is willing to Hotel Room Nights consider, in good faith, a price quote. Iodine • GSK will refrain from additional price negotiations Kraft Paper outside of the e-RA, except to clarify final logistical Labels details as are typically reserved until after the Lucozade Coolers bidding. Malted Barley/Extracts • All parties will prohibit unethical behavior and are MRO expected to notify the service provider if they Office Furniture witness practices that are counter productive to the Paracetamol fair operation of the e-RA. PC Periphe-RAls (Consortium) Plastic Bottles Contained in the RFQ: Professional Engineering Services • RFQ questions and updates: additional information, Promotional Items including responses to individual supplier questions, Promotional Print is shared with all participating suppliers via e-mail. PVC Films • Lot structures will have clear instructions of R&D Raw Materials requirements. Road Freight (Primary Trucking) • Conduct of the parties: GSK will fairly and Solvent - Phenol III objectively analyze all bids received against the Structural Steel requirements contained in the RFQ. Sucrose (Sugar) • Bidders are to conduct themselves in an open, Supply and Storage Bulk Nitrogen honest, and ethical manner during the bid process. Telemarketing Any bidder who seeks favor from any GSK employee Teleservices or agent during the bid process will be disqualified Toothpaste Outsourcing from proceeding. UM R&D Cabling • Award decisions: GSK strongly encourages all Vending Machines suppliers to bid competitively across all lots to be Vitamin C & Premix considered favorably for an award. All prices and pricing structures, as negotiated through the online e-RA process, will become effective immediately following the final award decision. However, GSK • Participant difficulties must be communicated to will not necessarily award to the lowest bidder(s). service provider immediately. Difficulties include any event or problem that interferes with the bidder’s Conclusion ability to participate in the e-RA and may include, The attitude towards GSK’s use of e-RAs is best but are not limited to, data entry errors, software summarized by comments from people that have been problems, or hardware problems. Participants have intimately involved in their use, as follows. five minutes after a lot goes into pending status to notify service provider of any problems. If the service

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• Director of GSK’s e-Sourcing: “This [use of e-RAs] that each employee has a personal safety plan, including is an incredible experience … while there’s risk all office personnel. Zero accidents are Bechtel’s goal, associated with being an early adopter, the internally and externally. opportunities and rewards of pioneering this space are fantastic!” Role of Reverse Auctions at Bechtel For projects in the Power, Petroleum & Chemical and • Director of GSK’s Global Systems and Processes: Mining & Metals business sectors the Bechtel cost “We’re going to put over $2 billion of spend through breakdown is: our e-sourcing program in 2003 with a target of $1 billion being reverse auctions. This is a tremendously • 50 percent of the spend is for material and successful program. We are leveraging supply and equipment. demand real time, online. This is good for GSK and • 40 percent of the spend is for construction services. even better for the supply base. Only the best • 10 percent of the spend is for engineering, suppliers can compete long term in this environ- procurement and construction (EPC) services to ment. It promotes high quality, low cost, lean design, procure for, and manage the project. processes and innovation … all the traits we’re looking for in supplier relationships.” Bechtel considers that 67.5 percent, for projects spend with this typical cost breakdown is potentially • Vice President, Procurement Finance: “At the end of auctionable, if a clear scope can be developed and a the day it’s about having made significant competitive supply market exists. Non-auctionable spend contribution to the bottom line. The accountability includes performance specified equipment (3-5 pieces, that this procurement team has achieved within the 12.5 percent of spend), for which few suppliers are business is outstanding … not only are there available. Additionally, goods or services with a rigorous processes in place to validate the major requirement for high levels of buyer/supplier savings achieved, but the focus on supply, quality, collaboration are not good electronic reverse auction and service remains consistently high.” targets.

Bechtel has rapidly ramped up from six e-RAs in 199 to a Bechtel planned 125 e-RAs in 2002. However, it is on track to complete about 400 e-RAs in 2002. Six of Becthel’s seven Company Background strategic business units have participated in e-Ras, and Bechtel (www.bechtel.com) is one of the world’s largest over 300 personnel are trained in reverse auction usage. engineering-construction firms. Founded in 1898, Bechtel provides premier technical, management, and Bechtel is committed to using reverse auctions as a directly related services to develop, manage, engineer, critical sourcing tactic. It believes reverse auctions offer build, and operate installations for customers worldwide. direct and indirect, financial and non-financial benefits. Currently Becthel’s 50,000 employees team with customers, partners and suppliers on 950 projects in 67 Operating Reverse Auctions countries. In 2001, Bechtel booked $9.3 billion in new Bechtel uses an internally developed, robust, e-request for business and worked off $13.4 billion in revenue. Bechtel quotation (e-RFQ) system capable of receiving and is privately owned and in its fourth generation of Bechtel transmitting complex specifications and drawings. family leadership. Bechtel’s business sectors include: Becthel’s goal in using the e-RFQ is to develop a total engineering, procurement, and construction management installed cost (TIC) for goods and services purchased for (EPCM) for Civil and government infrastructure; power, projects. Total installed cost is calculated using the petroleum, & chemical; mining & metals; and following formula: Telecommunication. Y = mX + b, Until approximately 20 years ago, Bechtel did not engage in negotiations with suppliers and accepted only sealed where, bids for equipment, goods, and services. In 1999, Bechtel began using e-RAs. Today negotiations and reverse Y is the total installed cost auctions are considered critical success factors for the X is the bid price business. Bechtel believes that reverse auctions shift the m is a cost multiplier (e.g., duty, currency exchange, advantage from the seller to the buyer if the market etc.); m can be more or less than 1.0 environment is correct. Safety and quality are critical b is a cost adder (e.g., transportation, cost of doing supplier qualifications. For Bechtel, safety is so critical business, etc.); b can be plus or minus.

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Figure 9 Bechtel Reverse Auctions

Reverse Auctions

Reverse Auction Events

400 400

350

300

250

Count 200

150

100 59 36 50 29 6 0 99 00 01 02 A 02F Year

RFQs and traditional purchasing methods are used to 1. Bidders receive an e-mail notification a few days determine the values of m and b for each bidder. before the e-RA. The e-mail will include the following event specific information: The Bechtel process for conducting an e-RA is depicted • date, time, and duration of the e-RA in Figure 10. • hyperlink to Bechtel e-auction Web site • user name Bechtel uses a self-service auction model. Its internal • randomly generated password domain expertise precludes the need to purchase 2. A reserve price is established before the start of e-RA. additional sourcing or e-RA services. This is the maximum price at which Bechtel will commit to award business through this e-RA. If the Bechtel operates its e-RAs with the following rules in reserve price is not met, Bechtel may declare the place. event null and void.

Figure 10 Bechtel E-RA Process

Issue RFQRFQ Receive/ Select qualifiedqualified package evaluate proposals bodders package evaluate pro posals bidders with auctionaucti on rules r ules

Program thethe event event using using Determine bidder bidder the e-RA software (This the e-RA software (This Establish thethe equalizer factors factors takes a buyer only about reserve price (m and b) takes10 minutes.) a buyer onl y about reserve price (m and b) 10 minutes.)

Train bidders Conduct e-RA Train bidders Conduct e-RA AwardAward the the businessbusiness

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3. A ceiling price is established. This is the maximum Training bid a supplier can submit during the event. Beyond the cost running an e-reverse auction, the biggest 4. Two minimum bidding decrements are established. barrier is the lack of e-reverse auction knowledge, The first is the minimum amount by which a bidder understanding how e-RAs work, and ensuring the proper can lower its bid at one time. If a supplier bid is 10 use of an e-RA. Over 300 people at Bechtel are trained in percent below its last bid, it receives a notification the use of e-reverse auctions. Each individual requires 13 asking if that is a correct bid. The second decrement hours of training. “Hands-on” training affords better prevents a supplier from lowering its bid by more results than videoconference training. In a two and one- than 25 percent at one time. half hour training session, Bechtel can discuss a previous 5. During the e-RA, bids are ranked using the TIC e-RA, then run and rerun the reverse auction. Bechtel formula. Bidders receive instant feedback on their records all auctions for debriefing and training activities. rank. Rank position 1 has the lowest TIC. When rerun, the recorded e-reverse auction looks 6. Proxy Bidding — To ensure that every bidder has an identical to a live e-RA. opportunity to participate, a proxy bidding service is provided. Phone bids are accepted at Bechtel e-RA A training and reverse auction enabler is a Bechtel operations center. A Bechtel representative will champion. Bechtel appoints individuals as companywide submit the supplier’s bid to the auction. champions for reverse auction adoption and success. The 7. All conversations during proxy bidding are champions have accelerated e-RA acceptance and recorded.The e-RA will continue beyond its adoption. scheduled closing time if the first-, second-, or third- ranked bidders continue to submit lower bids. Conclusion 8. After the e-RA closes, the supplier with the lowest Bechtel performs electronic reverse auctions because they TIC is notified via e-mail. believe e-reverse auctions:

Outcomes • provide competitive advantage Bechtel calculates savings from budgets established • provide lower market pricing during the initial phase of a project. The direct financial • provide lower cost for material, equipment, and benefits achieved from reverse auction have averaged services over 10 percent, with a range of 1 percent to 20 percent. • save negotiation time Over 90 percent of Bechtel’s e-RAs have achieved savings • determines total installed cost for all bidders from budget. Bechtel considers the critical success factors are: At Bechtel, e-RAs have not decreased the overall cycle- time from RFI to award, although the actual negotiation • Market and cost knowledge time is decreased from weeks to hours. However, e-RAs • Clear scope with minimal uncertainty require increased discipline in the work process and a • Selection of qualified bidders in competitive bidding better understanding of competitive markets. The environment preparation work is more detailed and the output higher • Integrity, ethics, professionalism, and fairness quality than achieved with traditional sourcing methods. • Training, planning, and organization

Bechtel views the non-financial benefits of e-RAs as equally important to the financial benefits. These benefits Volkswagen include: Overview of the Volkswagen Group (VW) • Improved negotiation results. There is a range of The Volkswagen Group’s activities focus on the negotiation skills among the buyers and top automotive market, and VW offers products and services, negotiators are not available for all buys. Bechtel gets such as financing and leasing, along the entire automotive as good of or better results, in less time, from reverse value chain. Nine independent brands belong to the auctions than from its best negotiators. Group: AUDI, Bentley/Rolls Royce, Bugatti, Lamborghini, • Projects are time and schedule-driven, and reverse Seat, Skoda, VW, and VW Commercial Vehicles. auctions assist in keeping projects on time. • Supplier performance is as good, if not better, than In 2001, Volkswagen produced more than 5 million business awarded when auctions are not used. vehicles in 45 plants worldwide. Sales in that year were • Bechtel has found that reverse auctions assist in 88.5 billion Euro; the number of employees 322,070. better understanding market prices. Headquartered in Germany, the Volkswagen Group is represented in all major markets of the world. Its

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worldwide market share is 12.5 percent; in terms of 7 percent — North America regional markets the share is 30.2 percent in Germany, 6 percent — Latin America 18.9 percent in Western Europe, 31.9 percent in Central/ 6.3 percent — Asia Eastern Europe, 6.6 percent in the United States, 22.7 0.7 percent — rest of the world percent in South America, and 51.3 percent in China. The final sourcing decisions are made by the cross Volkswagen enjoys a high reputation in its home country functional Corporate Sourcing Committee (CSC). In this Germany, similar to that of Toyota in Japan. In terms of committee, the CPO, the heads of the LPTs, the heads of continuous growth since the 1950s, the company is a purchasing for each brand, R&D, cost management, national success story. In the 1950s and 1960s, the quality management, logistics, and production come company became world famous with the Beetle, also together. The sourcing recommendations presented by known as the People’s Car at that time. The company has the single buyers have to get approved by this committee. successfully build a reputation as a producer of reliable This is the standard procedure for both the so-called and affordable cars engineered in Germany. While its global sourcing decisions and so-called forward sourcing customers enjoy “Fahrvergnügen,” and its workforce is decisions. Global sourcing means that the items are in proud of the products, VW is also known for its production already whereas forward sourcing is for parts innovative approaches to managerial problems. During a prior to the start of production (early sourcing). severe economic downturn in 1994, for example, VW took a new stakeholder-oriented approach to protect its VW pursues all modern purchasing strategies discussed employees from ups and downs of economic cycles and in the automotive industry, such as standardization, introduced the four-day workweek for VW employees, modularization, simultaneous engineering, globalization, combined with flexible hours, core time for specialist development of new suppliers in regions like Southeast workers, and early retirement provisions. This so called Asia, and early sourcing including concept/design “Breathing Factory” initiative involved the Board of competition among suppliers. Figure 11 shows the major Management, Work’s Council, and the trade union. fields of collaboration between VW and the supplier community. With a Group-wide purchasing volume of 59.9 billion Euro in 2001, which equals roughly 68 percent of total Also, VW considers itself at the forefront of innovations sales, VW’s suppliers play a key role in driving the in purchasing management when it comes to electronic company’s success. sourcing. The Volkswagen Group already manages nearly its complete procurement volume of almost 60 billion The Strategic Sourcing Context of E-RAs at Euro via the Internet. The Internet platform started in Volkswagen early summer of 2000 is up and running. Under the VW has build up a highly effective global purchasing domain “VW Group Supply.com” the most important network over the last decade. A matrix structure is used components, online catalogs, online inquiries, online for group/central purchasing with the brands forming one negotiations, and capacity management have already been dimension. The other dimension consists largely of the introduced. (Volkswagen uses the term online material groups (metal, power train, chemical interior, negotiations instead of e-RA.) VW points out that the chemical exterior, electric, and machinery & equipment) main advantages of this private B2B supplier platform are and the global/forward sourcing function. Sourcing the reduction of administrative tasks, the acceleration of activities are supported by regional purchasing teams processes, improved planning accuracy, and improved (also called LPT for local purchasing team) in core transparency in the collaboration with its suppliers. All sourcing markets. These teams are integrated into applications are free of charge for the suppliers. Across all sourcing processes across the entire Group. The applications, more than 500,000 transactions have been advantages of having local staff right on site are performed with more than 5,500 suppliers. As of numerous: not only do they have local procurement September 30, 2002, the transfer volume per application skills, but they also speak the local language and are is illustrated in Table 4. familiar with particularities in the relevant market. Regional purchasing offices not operating under a Figure 12 details the VW Group Supply.com brand are responsible for the regional supply markets infrastructure and positions online negotiations. in Benelux/France, Israel, and Japan/Korea. Key Characteristics of Online Negotiations at Volkswagen Group’s sourcing footprint is as follows: Volkswagen As mentioned above, Volkswagen uses the term online 54 percent — Germany negotiations instead of e-RA. This is done mainly for two 26 percent — other European countries reasons. First, the term “auction” implies that the bidding

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Figure 11 VW/Supplier Areas of Collaboration

Table 4 VW Application Transfer Volume

Online Inquiries • 5,500 suppliers linked • 530,000 inquiries processed Online Negotiations • 9,000 suppliers have participated at various times • 1,900 online negotiations conducted • 22.8 billion Euro turnover in volume (during contractual period) negotiated Online Catalog • 575 suppliers linked globally • 775,000 articles in global catalog • 7,500 internal users Capacity Management (eCap) • 200 suppliers integrated; among those 60 already migrated to the new eCAP/3 release • 4,000 critical parts identified

process results in a winner; in other words, the result is VW’s e-sourcing initiative is strongly supported by its top binding. While this is in general the case at VW, because management. Jens Neumann, member of the Board of in 80 percent of all cases the lowest bidder gets the Management for Group Strategy, Treasury, Legal Matters business, this is not always the case. In the remaining and Organization, stated: “Our strategy to concentrate 20 percent, VW chooses another bidder, either directly on process improvement and using Internet technology after the electronic bidding event or after post-event, as an enabler has proved to be right.” In line with this traditional, face-to-face negotiations. In these cases the statement purchasing managers at VW point out that the electronic event is a part (the online part) of the overall primary goal of online negotiations is not to achieve cost negotiation process. Second, the term is used to point out savings for direct material, but to improve purchasing that the electronic events are a natural part of the usual productivity. VW feels that it had a highly effective purchasing process. They do not replace the global- and sourcing organization prior to the introduction of online forward-sourcing processes established within the Group. negotiations and that the prices achieved were already the They also do not replace the decision-making process in best in the industry. The main objectives therefore, of the central decision committee, the Corporate Sourcing online negotiations, are: Committee. Rather, the online negotiation tool is integrated in the proven processes — “to make 1. to reduce cycle-time something good even better.” 2. to reduce negotiation complexity and process cost

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Figure 12 VW Online Auction Positions

Logistics / Marketing / Development Sourcing Producation Sales

3. to improve market transparency for both VW and Given this “can-auction” mentality, it is not surprising to the suppliers see that in 2002 about 20 percent of Volkswagen Group’s spend was sourced through online negotiations. 4. to be able to act on a worldwide basis Management expects this figure to go up to 40 to 50 percent over the next two to five years. Managers at VW emphasize that online negotiations are viewed in a larger context. They should not substitute the To achieve this high level of online negotiated spend personal contact between the buyers and their suppliers management, Volkswagen has to continue to manage the — quite the opposite. The administrative workload of change toward online negotiations. VW estimates that the buyers, which could imply that up to 50 percent of a majority of buyers still has to learn to use the new, buyer’s time is used to key in data, should be reduced in improved process. However, this will take time. order to be able to work more on strategic topics with Volkswagen’s philosophy: “This is a process, not a matter suppliers. To this end, VW ensures a seamless flow of of one day of training.” To speed up the implementation sourcing data as the results from eRFxs are automatically of online negotiation, VW Group Supply has set targets transferred to the online negotiation tool. The results for each commodity group in terms of numbers of events from the negotiation tool can then be automatically to be carried out and spend to award through online uploaded by the buyers to prepare their presentations of negotiations. In order not to give buyers the impression the sourcing recommendations to the Corporate Sourcing that they have to “take their hands off the wheel” when Committee. Buyers estimate the average cycle-time negotiating online, no rules have been established about reduction to the range from 10 percent for complicated when to use certain auction formats such as best-bid or modules to 50 percent for simple parts like corrugated rank. Currently, the ratio of these two formats is about cardboards. 50:50 at VW.

When it comes to selecting purchase items for online Volkswagen forcefully tries to build up a strong negotiations, VW has a clear position: all items are reputation as a trustworthy online buyer in the generally suitable for online negotiations. Under the automotive industry. This is done by carefully ensuring realistic assumption that a major automotive company up front that all participants meet Volkswagen’s technical almost always will find enough suppliers to bid for its and commercial prerequisites so that everyone has equal requirements, the only obstacle is to clearly specify the opportunities during the negotiation. Further, e-Sourcing need. One VW executive said, “All suppliers have to Management and Group Supply try to inform and train understand what you need, and you need to be able to the suppliers in a highly professional way. Suppliers are compare their offers. So, if you do a lot of input in the informed about the date and precise regulations on time. preparation phase, you can really auction or online Before an online negotiation, test runs are performed to negotiate everything.” familiarize all participants. Figure 13 shows an example

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Figure 13 VW Sample Invitation

Forward Service Enquiry: FVW 00 7205 Light Metal Wheel 7x17 (Centelon Lack): 1T0 601 025 8

Online Negotiation: VW E LIGHTMETALWHEEL 1 PQ35 D2101 L

Dear Ladies and Gentleman,

The Internet provides new opportunities for business transactions, ensuring all business partners advantages in terms of increased process facilitation, speed and cost efficiency.

Online negotiation of offers by means of Internet online-bidding is one of the new opportunities. This enables you and VW to achieve significant cost and time savings compared to the previous negotiation practice.

We would like to realize the benefits of cooperating with you and thus intend to negotiate online your bid on the above stated contract volume on November, 2 at 10:00 a.m. (GMT+1).

You have been appointed as responsible contact person during the online negotiation by the buyer, [name]. Should you not be available or if there are any amendments, please let us know. Should your company want to appoint another contact person for this online negotiation, could you please furnish us with this person’s contact date, i.e., name, function, telephone number, fax number, mobile phone number, and e-mail address.

May we kindly ask you to send the required phone/fax numbers to [name, title, e-mail] by Thursday, November 1, 2001, 12:00 a.m. (GMT+1).

During online price negotiations you will be able to see your bid (a price per unit for 50% and 100%, logistic cost per unit for the consuming plants, invest, and long term conditions in comparison to your quartile position. In case a new best bid is made, you will see any changes immediately and have the chance to respond accordingly. However, data are kept confidential, so that you will not be able to identify the bidder of the most favorable bid. You may improve your bid at any time and as often as you like by a minimum of 0,10 Euro (a price), 0,01 Euro (logistic cost), 1000 Euro (invest) and 0.25 steps for ratios. At the beginning of the online negotiation, you will see your offer as received in the writing/ESL. In case you have not made any offer yet, you will have to enter your first offers directly after the online negotiation has started.

Technical Requirements: All you need is a secure connection to the Internet and a browser, either MS Explorer 5.0 [Web site] or Netscape Navigator 4.7 [Web site]

In order to be able to follow up the auction process, you should be provided with the following hardware: • Computer, Pentium (> = 200 MHz) • Modem: 56k or ISDN • ROM: . = 64 MB • Operating System: Windows 95, 98, 2000 or NT • Screen: 600x800 pixel

Please inform your contact person to be prepared for online price negotiations on November 2 at 10:00 a.m. (GMT+1). Please make sure that you are logged in on time! Negotiations will take 10 minutes, and will be extended twice automatically by 5 minutes, if lower bids are offered within the last 5 minutes towards the end. Altogether you should be prepared for at least 20 minutes. To improve and update your offer during the negotiations the contact person should have the relevant decision power from your company or you should ensure that the relevant decision makers are available during negotiations.

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Figure 13 (continued)

We kindly ask you to confirm your latest bid in writing after online price negotiations.

VW – i.e., the relevant decision-making bodies – will then place a contract with the most favourable bidders. Having placed the bed bid is the most important decision criterion.

Should you have any further questions concerning the FS enquiry, please contact the responsible buyer, [name, phone number]. For questions regarding the online negotiation, please contact [name, phone number, e-mail address].

Yours faithfully, [name] [title] [company] [address] [phone number] [e-mail address]

of an invitation to an online negotiation to pre-selected Key Learnings VW-suppliers. “Bird watching” is usually not tolerated. If Key learnings from the interviews with this “super-user” a supplier does not submit a new, competitive bid after a were: certain time during the auction, VW sends a individual message to this supplier through the auction tool’s • The primary goal was efficiency/buyer productivity, messaging system letting the supplier know that if it does not direct cost savings. not reach the next (intermediate) target, it will be • Whatever can be specified clearly can be auctioned excluded from the rest of the event. Buyers are strongly successfully. recommended to conduct follow-up discussions with the • S large portion of direct cost can be covered through suppliers after the events to provide feedback and online negotiations. improve their online negotiation skills for future events. • There is an ongoing need for active change Due to this high degree of professionalism, neither management and top management support for Volkswagen nor the suppliers of VW interviewed online souring activities. expressed any concerns about online negotiation-specific • For a successful roll-out of online negotiations in the unethical behavior. supplier community, a strong reputation as a highly professional and trustworthy online buyer is key. In the beginning of the online negotiation initiative, • Experienced users treat provider services largely as a Volkswagen also tested the full service offers of service technology commodity. providers for selected purchase items. The result was that • The new technology can be successfully used in a these could not offer significant advantages in terms of global sourcing context. market making or finding better suppliers. Volkswagen developed its e-sourcing competence with the support of eBreviate. The decision to buy the software, to METRO Group continuously improve and customize it, and to keep all data for VW and the suppliers inhouse was taken early Company Background and Group Buying for two reasons, a) data security and b) protection of The roots of the companies belonging to METRO group VW’s competitive advantages. today go back to the 19th century in some cases. However, 1964 is generally held to be the birth year of As Volkswagen tries to bundle purchase power to the the METRO company: Otto Beisheim opened the first largest extent possible and uses online negotiations METRO Cash & Carry store in Germany, a wholesale worldwide, researchers were also interested to learn market where traders could collect their merchandise whether regional differences exist in the acceptance of against cash. The pioneering spirit of Beisheim and online negotiations either on the buyers’ side or on the innovative business models characterized the develop- suppliers’ side. While acceptance was slow in Brazil at the ment of METRO at all times. In 1996, METRO as we beginning and still is in Spain, two regions, Mexico and know it today was created within only 10 months the Czech Republic, were mentioned as highly receptive by merging three major independent German retail to the new technology and the innovative process. companies that each had their own long traditions. The

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newly formed company went public the very same year. a cost center, the strategic mission of MGB is to use “its On July 25, 1996, the METRO stock was quoted on the strategic potential in negotiations and co-operations with German DAX for the first time. Based on its successful domestic and foreign suppliers to effectively improve the performance in the domestic market, the group soon buying conditions for the METRO Group.” Its services expanded into foreign markets as well. Today, with more include the negotiation of conditions for buying and than 2,200 locations in 26 countries METRO Group is payment, the sample meetings, listing, sales promotion, the third largest trading and retailing group in Europe and merchandising as well as constantly keeping and the fifth largest in the world. The company employs suppliers’ data and article data up-to-date. MGB feels it is around 230,000 people (186,000 if converted to full-time doing a highly important job within the group as the equivalents). In 2001, METRO generated sales of almost effects of a buying unit’s performance are more directly 50 billion Euro, some 5.5 percent more than in the reflected in the sales price in the retail industry than may previous year, 44.4 percent of which come from outside be the case in others. of Germany. As of December 31, 2001, METRO’s market capitalization was 12.9 billion Euro. Integration of E-RA and the Strategies and Processes of METRO Group Buying (MGB) The operating business is divided into four business units METRO started with electronic reverse auctions in 2000. in which six so-called sales divisions act independently in As of September 30, 2002, METRO has conducted 750 the market with their individual brands. Cross-divisional auctions with an overall volume of 680 million Euro. It is service companies, such as procurement, logistics, IT, expected that in three to five years up to 10 percent of the advertising, financing, insurance, and catering, provide annual purchase volume will be bought through auctions. services to all sales divisions. The six sales divisions are: METRO C&C Wholesale in the cash-and-carry business The METRO board member responsible for purchasing unit (423 outlets in 23 countries); REAL hypermarkets strongly supported the initiative and top management and Extra food stores in the food retailing business unit was involved in the e-RA initiative from the very (771 outlets in 3 countries); Media-Saturn consumer beginning as METRO had to make an investment electronic centers and Praktiker Do-it-yourself in the decision that finally resulted in taking a significant equity non-food specialty business unit (720 outlets in 12 stake in the marketplace: GNX (GlobalNetXchange; countries): and the department store line Galeria Kaufhof www.gnx.com). Other equity partners include Carrefour, (149 outlets in 2 countries). Kroger, J. Sainsbury, Coles Myer, Sears Roebuck, Oracle, and PWC/IBM. While GNX is seen as an important The major pillars of the strategy of profitable growth are: business partner in METRO’s auction initiative, MGB would never consider buying full services from any • the optimization of the distribution concepts service provider — “Se rent a car, but will never let • the optimization of the portfolio somebody else drive it.” • the internationalization of the company The overall goal of the e-RA initiative was to achieve All organizational units of METRO Group have a higher market transparency and increased process common performance, leadership, and social policy efficiencies as compared to face-to-face negotiations. It identity. This is expressed by main strategic guidelines of was expected that in many cases, the savings in terms of METRO Group, the so-called 12 Corporate Principles. price and process efficiency would be at least twice as Further, METRO follows the German Corporate high as in the traditional mode. MGB’s long-term vision Governance Principles. These serve to make transparent for e-RA is as follows: the responsible management of METRO, directed toward real net output, and to control, safeguard, and improve • Auctioning is a standard application for all buyers the high standards of the business activities of the within the METRO Group. METRO Group. They also promote and enhance the trust • The buyer is using the application for all of present and future investors, customers, employees, “auctionable” purchase activities. The application can and the interested public on national and international include requests for information, requests for markets and, thus, to further the acceptance of METRO quotation, or e-RA. on the international capital markets. • Auctioning is an integral part of the standard training of all buyers and assistants within the METRO METRO Group Buying (MGB) is a 100 percent subsidiary Group. of the METRO Group (METRO AG). It was established in • All necessary supplier contact data can be accessed 1993 as the central purchasing unit of the METRO or entered by the buyer without special support. Group. It employs around 780 people. MGB handles • The internal support is focused on questions related above 43 billion Euro of purchases per year. Operating as to auction strategies and tactics.

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METRO’s e-buying process generally consists of four Figure 14 shows that METRO sees the preparation phase phases. The first phase is internal pooling of demand; the as key. second is request for information; the third is request for quotation; and the fourth is the reverse auction. During Consequently, expectations for cycle-time reductions are the three phases preceding the auction, all aspects except moderate: for the price are set (i.e., sample tests are done and supplier audits are conducted). Therefore, everything can “Total time to contract (TTC) is shorter only for be auctioned according to MGB — it is only a matter of repeat buys. However, the process quality is whether it can be described precisely: significantly improved. This will be decisive in tomorrow’s competitive arena. When everyone is “I have to tell the suppliers clearly what I want. using the tool in a couple of years, there will be no Complexity in terms of technical complexity is not comparative advantage in terms of savings (price that important. We auctioned the construction of and process). The only thing that will matter then is whole stores including the freezing equipment and whether or not your process quality is higher — the facility management – everything. Yes, it is hard these auctions should allow you to buy smarter, to to define what you want in cases like this, but at the focus on strategic issues, and not to waste so much end we had three highly competitive suppliers that time wrestling about price.” bid in the auction. After half a year there was the common understanding there. And, by the way, I METRO summarizes the main advantages of e-RAs: think that all this work had to be done anyway, no matter if you do an auction on price at the end or 1. Forces each buyer to do a sophisticated negotiation face-to-face negotiations.” preparation 2. E-RAs increase efficiency of negotiations: “five to 20 In the beginning there was the fear of loosing the negotiation rounds in 90 minutes.” flexibility which is inherent to face-to-face negotiations. 3. Sales persons are bidding in their offices “However, this does not take place; the traditional format — Multiple internal colleagues (e.g., production and is just replaced when it comes to negotiating price, logistics) can attend. everything else is negotiated up-front in the traditional — Suppliers can contact their suppliers directly. way — maybe in a different order.” 4. Has the psychological effect of “no gambling.” — Salesperson: “Now I know where I am in my MGB has identified three key success factors for auctions: competition.”

1. Two to three actively competing suppliers Communicating the advantages and limitations of 2. No conflicts with existing agreements auctions to both buyers and suppliers was of highest 3. Specifications and quantities are available priority during the whole roll-out of the e-RA initiative.

Figure 14 E-RA Process at METRO

Purchasing strategy Auction tactics Bid controls

90% efforts 100 % success

10% efforts

•Set up of Auction •Product Specification in GNX •Logistical issues •Supplier Screening •Sample Check •Supplier Training •...

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METRO started in 2000 by bringing buyers and division A further measure to secure high professional standards is managers together in a focus group. After about six that METRO has all employees participating in auction- months the team came to the conclusion that auctions related activities sign a form declaring their compliance will work for the METRO organization. Since then, with competition and antitrust laws as well as with the regular planning rounds are conducted for e-RA activities. GNX Code of Conduct. These two documents are There are basically two planning rounds per year, a major reproduced in Figures 15 and 16. one with detailed targets and a second one that serves as an opportunity to update the plan and to adjust actions Due to these strict measures, it does not come as a in the middle of the year. Furthermore, MGB keeps surprise to see positive effects resulting from auctions in management attention and commitment high through terms of ethical behavior. One executive said: monthly reports covering all auction activities. These reports demonstrate the bottom line effects of the group “Unethical behavior? Nothing really changed. to the board and to the top executives in charge of each Things become even more transparent for all parties of METRO Group’s six sales divisions. involved. Buyers, salespersons, and their respective managers can take a look into the negotiation room Another measure helped implement the concept quickly and see what their people have been doing.” and effectively: management never criticized buyers for any previous result, meaning that if a buyer achieved for Despite the fact that METRO has conducted a large example 23 percent savings for an item through an e-RA, number of auctions so far, it has not undertaken efforts to he was not questioned whether or not he had done his analyze cross-event data in order to test for correlations job properly in the previous (non e-RA) years. Further, e.g., between the number of bidding suppliers and the intense feedback was provided to the buyers every time savings achieved. Based on the research interviews, the they conducted an auction. The same holds true for the conclusion was reached that many buying organizations supplier community — METRO wanted and still wants and service providers currently engaging in such efforts to make sure that all suppliers, including those who did are on a fishing expedition and do “measurement without not win the event, are motivated to participate in future theory.” METRO therefore is focusing the efforts on auctions. During the entire international roll out, METRO communicating negotiation experiences among all buyers did not face any country- or culture-specific hurdles. on a regular basis.

The managers at MGB feel that METRO has built up a Purchasing managers at MGB gave the general advice that strong auction reputation. This might be because METRO the whole e-RA issue has to be kept simple and transparent puts utmost emphasis on ensuring that its auction from the beginning for both buyers and suppliers in activities are conducted in accordance with high ethical order to achieve an effective and fast implementation. and legal standards. This is done by following a set of “METRO ‘Golden Rules’ for Buyers and Suppliers”: Key Findings The key learning’s from the interviews with METRO were: 1. Auctions are complementing the classical way of price negotiation. 1. Top management was involved from the beginning; 2. Auctions are set up with the intention to award top management attention is kept high by monthly business. auction reports documenting the bottom-line impact 3. Bids outside of GNX must not be accepted. of auctions. In the case of re-bidding, the auction has to be re-set up. 2. The company has a dual goal: achieve higher market 4. All suppliers receive the same information and are transparency and increase process efficiency. treated equally. 3. Everything can be e-auctioned as long as it can be No exclusive information for any suppliers. specified; technical complexity is no major Identical rules for all suppliers. roadblock. Precision in preparation is key. All bidders have to be potential suppliers. 4. In general, e-RAs are nothing spectacular; they 5. Auction content has to be transparent. complement existing processes — things can and All aspects of the final decision should be included should be kept simple for all parties involved. within the auction. 5. Documents like “Golden Rules” and “Codes of All aspects beside price have to be mentioned. Conduct” help ensure that e-RA activities measure 6. Quantity, volume, and dates of an auction contract up to the highest ethical and legal standards. This are binding. increases external and internal acceptance, helps 7. Fictitious bids are absolutely forbidden for all building a strong e-RA reputation in the market, and participants. speeds up implementation. 8. All auction data has to be treated confidentially.

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Figure 15 METRO Registration Form + Undertaking

REGISTRATION FORM + UNDERTAKING

______Last name of employee Company (e.g., Metro France)

______First name of employee Work phone (e.g., +49–211-969-xxxx)

______Function (e.g., Buyer, Assistant etc) Work e-mail

______Department (e.g., Frozen Food)

Copy : Fax to +49-211-969-xxxx Original: Forward to your Local Auction Coordinator

My work with my employer, ______, a company of the METRO AG group (“METRO group”), comprises, among other professional activities, the handling of transactions via the GlobalNetXchange internet platform (the “Exchange”), respectively participating in these activities in a supportive manner.

I am aware of the fact that any contract or agreement on auctions, sales and purchases as well as any other transaction via the “Exchange” requires strict compliance with all applicable competition and antitrust laws, rules and regulations. I do know as well that in case these laws, rules and regulations are offended or infringed upon both METRO group and any individual staff member may face severe penalties, and that this may be severely injurious to the interests of or damaging to my employer and METRO group as a whole.

For these reasons, METRO ONLINE USA, Inc., a company of METRO group, has signed the “Code of Conduct” enclosed to this undertaking and is obliged to strictly comply with this Code of Conduct. Therefore, I have read this Code of Conduct in detail, and I undertake to accept and pay respect to it and to behave in such manner as shall not give rise in any way to any infringement of this Code of Conduct neither by METRO ONLINE USA, Inc. nor by any other company belonging to METRO group.

I ensure not to do any joint or collective purchases, nor engage in these, with companies not belonging to METRO group unless the person at MGB METRO Group Buying GmbH (formerly: METRO MGE Einkauf GmbH) responsible for GNX matters, currently Mrs. Svoboda, expressly instructed me to do so and only after the legal situation and the facts have been closely examined and scrutinized.

The aforementioned undertakings shall be an integral part of my contract of employment. They shall, without prejudice thereof, remain in effect and be complied with not only throughout the duration of the contract but also after my employment with the company of METRO group has been terminated.

______[place & date] [Signature]

Enclosure: Code of Conduct GlobalNetXchange

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Figure 16 Code of Conduct GlobalNetXchange

GlobalNetXchange (GNX) shall operate in compliance with all applicable laws at all times. In connection with applicable antitrust laws, three fundamental principles (Fundamental Principles) shall be complied with at all times by GNX and its Members when using the GNX Exchange (the Exchange). “Members” means each person who is a Member pursuant to that certain Limited Liability Company Agreement of GlobalNetXchange LLC dated as of July 20, 2000, and engages in the retail industry as a retailer, supplier or distributor. The “Exchange” means the internet connection www.gnx.com.

Fundamental Principle 1 All members shall separately and independently negotiate the purchase and sale of goods or services for resale. No joint or collective purchase and sale of goods and services for resale are permitted.

Fundamental Principle 2 No Member shall share with any other Member any information regarding the conditions of the purchase of goods and services for resale.

Fundamental Principle 3 GNX shall not share with any Member information regarding the conditions of the purchase of goods or services for resale negotiated by any other Member.

Application of the Fundamental Principles Pursuant to the Fundamental Principles, no joint or collective purchases and sales of goods and services for resale are permitted when using the Exchange. Each Member must separately and independently negotiate such purchases and sales without using information regarding the purchases and sales of goods and services for resale negotiated by any other Member. Neither GNX nor any Member may share with any other Member any information regarding the conditions of the purchase of goods or services for resale acquired as a result of the use of the Exchange. Joint purchases of goods and services not for resale may be engaged in by the GNX or Members, but only after the guidelines and procedures for making such purchases, including any related exchange of information, are approved by GNX.

Compliance with the Fundamental Principles It is essential that all employees of GNX, all employees of Members, and all employees seconded (or assigned temporarily) to GNX by any Member, whether full or part time, who acquire information concerning the purchase and sale of goods and services for resale as a result of the use of the Exchange, shall comply with the Fundamental Principles.

With regard to all employees seconded to GNX, the Fundamental Principles shall be complied with not only throughout the duration of the secondment but also after the end of such secondment when such employees return to the employ of the Member.

Failure by any Member to comply with the Fundamental Principles could result in the exclusion of that Member from the Exchange as determined by GNX. Failure of any employee of GNX to comply with the Fundamental Principles could result in the termination of that person’s employ as determined by GNX.

Implementation of the Fundamental Principles 1. The negotiation of the purchase and/or sale of the same category of goods and services for resale shall not be conducted by the same person on behalf o two or more Members using the Exchange.

2. Each Member and GNX shall adopt internal procedures to ensure that no information with regard to the conditions of the purchase and/or sale of goods and services obtained as a result of the use of the Exchange is shared with any other Member and that the Fundamental Principles are adhered to each of their respective employees.

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Figure 16 (continued)

3. Each Member and GNX shall appoint a manager responsible for implementation of and compliance with all internal information control procedures necessary to comply with the Fundamental Principles. In particular, the manager shall be prepared to verify upon request by GNX that such procedures are in place and no information developed as a result of the use of the exchange by one Member concerning the commercial strategies and/or conditions of the purchase or sale of goods and services for resale has been shared with any other Member, except as permitted by the GNX guidelines and procedures adopted with respect to the joint purchase of goods and services not for resale.

Certification of Compliance Each signatory and authorized representative of the Members executing this document acknowledges, on behalf o such Member, that it understands the Fundamental Principles and their importance in the lawful operation of the Exchange and according certifies that:

1. The undersigned Member will not directly or indirectly communicate information concerning the conditions of the purchase or sale of goods and services for resale, which it may acquire as a result of the use of the Exchange, to any other Member using the Exchange or any employee of GNX.

2. The undersigned Member will not seek to discover information concerning the conditions of the sale and/or purchase of goods and services for resale negotiated by any other Member with suppliers or sellers of such goods and services.

3. The undersigned Member will not use any information regarding the conditions of sale or purchase of goods and services for resale negotiated by any other Member acquired as a result of the use of the Exchange in any purchase or sale the undersigned Member negotiates.

4. The undersigned Member shall inform the manager at GNX responsible for ensuring compliance with the Fundamental Principles of any violation of the Fundamental Principles of which the undersigned Member becomes aware.

5. The undersigned Member acknowledges that these undertakings shall not be construed to prohibit joint purchases of goods and services not for resale that are permitted by the GNX guidelines and procedures or the exchange of related information among GNX and its Members.

Date: ______At: ______By: ______On Behalf of: ______

GNX and its authorized representative executing this document acknowledges, on behalf of GNX, that it understands the Fundamental Principles and their importance in the lawful operation of the Exchange, and accordingly, GNX agrees to comply with the Fundamental Principles and their implementing rules, guidelines and procedures at all times.

Date: ______At: ______By: ______

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A APPENDIX

Appendix A: Methodology

Determining the Sample of Study Participants The Site Visit and Interview Processes

The research team began the field research by conducting The team conducted day-long case study site visits with case study visits of third-party providers of e-RA services, 17 providers and 16 buying firm users, and in-depth and of buying firms that use e-RAs (users). To provide a teleconference interviews with 15 suppliers and nine full picture of the e-RA phenomenon, the team also non-users. Firms continued to be interviewed until a conducted in-depth interviews of suppliers to the case point of redundancy or what is called “saturation” was study buying firms, as well as in-depth interviews of met for each of the major informant groups — buyers, buying firms that currently do not use e-RAs (non-users). suppliers, providers, and non-users.

Third-party service providers were chosen to include The team followed a semi-structured interview protocol 1) the major providers (i.e., those with the most across cases and interviews, which, in contrast to an customers and in the business for the longest amount unstructured approach, allowed the team to be selective of time); 2) a variety or business models (e.g., full- in collecting data and facilitated the coordination of service, some services, and self-serve); and 3) industry- researchers across multiple cases in order to aid in cross- sponsored consortia that provided e-RA services along company comparisons. with other e-services. A draft buyer interview protocol was developed by the Buyer firms were chosen based on a requirement that researchers based on a review of the trade literature and they were at least “moderate” users of e-RAs, that is initial interviews with service providers. This draft having conducted more than 20 reverse auctions in interview protocol was then reviewed by e-RA providers 2001. Once this criterion was met, firms were chosen in and modified based on their feedback. A pilot test of the order to represent a diverse group of industries and interview protocol was conducted with two buyer user auction experiences, so as to derive a comprehensive set organizations, one in Germany and one in the United of findings. These buyer firms were identified through a States. Finally, the buyer interview protocol was further survey of firms at the 2002 CAPS Research International refined based on the results of these initial case study Executive Purchasing Roundtable. Attendees of this event visits. In a similar fashion, initial supplier and non-user are limited to chief purchasing officers of large firms interview protocols were developed from findings from (Fortune 500) that regularly participate with CAPS the user interviews and were further refined based on Research activities. In addition, a similar survey was sent feedback from these users. to other CPOs that were not in attendance at the 2002 Roundtable, but were active participants with CAPS Research. Further, providers identified some of their most Data Analysis frequent users. Finally, the team attempted to obtain matched perspectives of users and suppliers, by asking The case study and in-depth interviews were recorded each of the sampled buying organizations to identify two and transcribed. Interpretive notes were then constructed suppliers that had participated in their e-RAs that would for each organization, based on a compilation and be willing to participate in the study. As for non-users, comparison of the researchers’ field notes, interview they too were identified through the above surveys of transcripts, additional records such as company firms attending the 2002 CAPS Research Roundtable.

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APPENDIX A brochures and Web sites, and other internal documenta- tion. The use and comparison of these different data sources allowed the researchers to corroborate and ensure the reliability of the information that was used to develop the interpretive notes.

Next, the team developed broad coding categories that included general information questions, barriers encountered by buyers and suppliers, ways of overcoming those barriers, outcomes of e-RAs, and potential ethical issues surrounding e-RAs. Afterward, specific activities, or codes, for each of these categories were identified based on an iterative review of the interpretive notes. The same researcher then applied these codes to all of the interpretive notes for the buyer and supplier data. The reliability of the coding was tested by having two researchers separately code the field notes.

The coded interpretive notes allowed the team to aggregate the data, contained in the several hundreds of pages of interpretive notes, into matrices, in order to identify both commonalities and contrasts across company perspectives, and to more systematically interpret and present the findings contained in this report.

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B APPENDIX

Appendix B: Auction Typology

Long before the evolution of electronic reverse auctions, cases both.) For our purposes we will identify auctions as economists and mathematicians were studying auctions. having either one buyer and multiple sellers or one seller Much of their work is concerned with the theory of and multiple buyers. (Auction theory makes no distinc- auctions, bidding strategies, and observing outcomes tion between these two cases. However it is helpful to from subjects participating in experimental auctions.1 our understanding of auctions to make this distinction). A smaller, but growing, portion of the literature focuses on the best use of auctions for commercial transactions. The other important characteristic to know is if the Some of the different auction types that have found use auction is a forward (ascending) or reverse (descending) in commercial transactions are discussed below. auction. Forward auctions are often called English Unfortunately, the terminology of auctions is not entirely auctions, but a specific sub-type exists that is also called standardized. The terms employed below to describe an English auction. Reverse auctions are often called auctions are commonly, but not universally, used. Dutch auctions, but a specific sub-type exists that is also called a Dutch auction. There are two characteristics of auctions that help in their classification. First it is important to know if the auction These two dimensions yield a matrix with four cells as is a competition between sellers or buyers (or in some shown in Figure 17.

Figure 17 Auction Typology

eRAs (as Dutch Reverse discussed in this report)

“forward” English Dutch Forward Japanese

One Buyer One Seller Multiple Sellers Multiple Buyers

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APPENDIX B Forward Auctions with One Seller and Multiple Reverse Auctions with One Seller and Multiple Buyers Buyers

English sub-type This is the true or traditional Dutch auction. The seller offers the item (e.g., tulip bulbs or treasury bonds) for In forward auctions with one seller and multiple buyers, sale at an initially high price, higher than any buyer is offers to buy (bids) start at a low level, go up, and never expected to bid. The offer price is lowered over time in go down. As the bid price goes up, bidders drop out. The regular intervals until one buyer bids and wins the auction ends when the next to last bidder drops out and auction. In the literature this is called a descending, first- the last bidder wins the auction at his/her last bid. In an price auction. English auction, bidders can drop out and come back at a later time (assuming the auction has not closed) and can jump the bid by any amount. English auctions are Reverse Auctions with One Buyer and Multiple also called open outcry auctions (because bidders call out their bids.) Sellers

A more recent variation is the online auction typified by This is the e-RA discussed in this report. However, eBay. In this case, the buyers do not know or see the because it allows bidders to quit and reenter and allows other buyers. The auction proceeds as above, except that jumps in the bids, it does not meet the assumptions of it closes at a set time. The highest bid wins. the basic auction theory. The theory also does not account for the information suppliers glean from Japanese sub-type knowing other bids or the rank of their own bids, or for supplier bidding strategies (e.g., incumbents bidding In auctions of this type, all buyers are presumed to bid at somewhat higher than the lowest bid.) Furthermore, a starting (low) bid. Bids are increased in regular intervals inactive bidders may be dismissed from the auction by and jump bidding is not allowed. Bidders must publicly the buying company. signal they are dropping out and once out, they cannot return. Bidders drop out before the price is next raised. Many variations on these basic types of auctions exist. The auction literature refers to this as an open, second- Some of these are discussed below. price, ascending auction. The second price refers to the fact that the winning bidder wins the auction at the price at First-Price, Sealed-Bid Auction with One Seller and Multiple which the next to last bidder dropped out (the second Buyers price). Basic auction theory assumes ascending auctions meet these requirements. Each bidder independently submits a sealed bid for the item. The bids are opened and the highest bid wins. This Ascending auctions are commonly used to sell new and is called a first-price, sealed-bid auction. used equipment, antiques, cell phone spectrums, and many other goods and services. Second-Price, Sealed-Bid Auction with One Seller and Multiple Buyers

Each bidder independently submits a sealed bid for the Forward Auctions with One Buyer and Multiple item. The bids are opened and the bidder submitting the Sellers highest bid wins. However, the winning bidder pays the price of the second highest bidder (the second price). This auction type does not appear to be named in the The purpose of this rule is to encourage bidders to bid a literature. The research team found a company using this price equal to what they believe the value of the item to type of auction to buy non-complex, well-specified be. This type of auction is often called a Vickery auction, goods. In this auction the bid price starts at a value lower named for William Vickery, an auction theorist and Nobel than any supplier is willing to offer the good for sale. The prize winner. bid price goes up at regular intervals until one supplier bids and wins the auction. This is a first-price, ascending Sealed-Bid Auctions with One Buyer and Multiple Sellers auction. (The company referred to this as a Dutch auction, but this terminology does not appear to be These auctions work exactly the same as the above sealed standard or common.) bid auctions except that the lowest (or in the case of second-price, the second lowest) bid wins.

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B APPENDIX Auctions with Multiple Buyers and Multiple Sellers concerns: discouraging collusive, entry-deterring and predatory behavior. In short, good auction design is In these auctions, buyers’ offers will go up and sellers’ mostly good elementary economics. offers will go down, until a match or overlap is reached. This is the basic mechanism of stock and commodity By contrast most of the extensive auction literature is of exchanges. second-order importance for practical auction design.2

Multiple Units for Sale In this report we have tried to present the practical aspects of e-RAs that can lead to success for both buying When more than one unit of an item is available in a and selling companies. single auction, a different set of ascending Dutch auction rules are often applied. (The similar terminology is References unfortunate.) 1. Klemperer, Paul, “Auction Theory: A Guide to the The seller specifies the number of items available and Literature,” Journal of Economic Surveys, Vol. 13, No. buyers enter a bid equal to the starting price or higher 3, July 1999. and the quantity they are interested in purchasing. The auction ends when no more bids are forthcoming. The 2. Klemperer, Paul, “What Really Matters in Auction items are allocated starting with the last (highest) bidder. Design,” Journal of Economic Perspectives, 2002 This bidder gets the number of items he or she declared (revised). at the start of the auction. If items remain, they are allocated to the next highest bidder, who gets the number of items he or she declared. This continues until no items are left. All of the bidders pay the same price — namely the bid price of the final bidder to be allocated any items. This is of course lower than the highest bid.

Some Surprising Results from the Theory of Auctions

Under the mild assumptions that: a) bidders know the true value of the good to them, and these values are unknown by the other bidders; b) bidders are risk- neutral; and c) buyers do not collude; then auction theory tells us that:

first-price, sealed-bid auctions are equivalent to descending first-price (Dutch) auctions are equivalent to second-price, sealed bid auctions are equivalent to ascending second-price (Japanese) auctions.

In this statement, equivalency means equal expected revenue to the seller (and equal expected payments by the buyer). In other words, under certain assumptions, all four auction types results in the same expected outcome for the seller.

Auction theory has advanced beyond these statements by relaxing the assumptions and introducing others. However, these results are beyond the scope of this discussion. Unfortunately much of auction theory is of little value in designing practical auctions.

What really matters in auction design are the same issues that any industry regulator would recognize as key

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APPENDIX C Appendix C: Methodology References

Bonoma, T., “Case Research in Marketing: Opportunities, Meredith, J., “Building Operations Management Theory Problems, and a Process,” Journal of Marketing through Case and Field Research,” Journal of Research, Vol. 22, No. 2, 1985, pp. 199-208. Operations Management, Vol. 16, No. 4, 1998, pp. 441-454. Carter, Craig R., “Ethical Issues in International Buyer- Supplier Relationships: A Dyadic Examination,” Miles, Mathew B., and A. Michael Huberman, Qualitative Journal of Operations Management, Vol. 18, No.2, Data Analysis, Thousand Oaks, CA: Sage 2000, pp. 191-208. Publications, 1994.

Eisenhardt, Kathleen M., “Building Theories from Case Miller, W.L., and B.F. Crabtree, “Primary Care Research: Study Research,” Academy of Management Review, a Multimethod Typology and Qualification Road Vol. 14, No. 4, 1989, pp. 532-550. Map,” in Doing Qualitative Research, B. F. Crabtree and W.L. Miller, editors, Newbury Park, CA: Sage Ellram, Lisa M., “The Use of the Case Study Method in Publications, 1992. Logistics Research,” Journal of Business Logistics, Vol. 17, No. 2, 1996, pp. 93-139. Patton, Michael Q, Qualitative Evaluation Methods, Beverly Hills, CA: Sage Publications, 1990. Glaser, Barney G., and Anselm L. Strauss, The Discovery of Grounded Theory, New York: Aldine De Gruyter, 1967. Spradely, J.P., The Ethnographic Interview, New York: Holt, Rinehart, and Winston, 1979. Kuzel, Anton J., “Sampling in Qualitative Inquiry,” in Doing Qualitative Research, B.F. Crabtree and W.L. Strauss, A.L., Qualitative Analysis for Social Scientists, Miller, editors, Newbury Park, CA: Sage Cambridge, UK: Cambridge University Press, 1987. Publications, 1992, pp. 31-44. Strauss, Anselm L., and Juliet Corbin, Basics of Qualitative Lincoln, Yvonna S., and Egon G. Guba, Naturalistic Research: Grounded Theory Procedures and Techniques, Inquiry, Beverly Hills, CA: Sage Publications, 1985. Newbury Park, CA: Sage Publications, 1990.

Marshall, Catherine, and Gretchen B. Rossman, Designing Vyas, N., and A.G. Woodside, “An Inductive Model of Qualitative Research, Newbury Park, CA: Sage Industrial Supplier Choice Processes,” Journal of Publications, 1995. Marketing, Vol. 48, No. 1, 1984, p. 30-45.

McCracken, Grant D., The Long Interview, Newbury Park, Weller, Susan C., and A. Kimball Romney, Systematic Data CA: Sage Publications, 1988. Collection, Newbury Park, CA: Sage Publications, 1988.

McGrath, Joseph E., “Dilemmatics: the Study of Research Yin, R.K., Applications of Case Study Research, Washington, Choices and Dilemmas,” in Judgement Calls in DC: Cosmos Corporation, 1991. Research, J.E. McGrath, J. Martin, and R.A. Kulka, editors, Beverly Hills, CA: Sage Publications, 1982, Yin, R.K., Case Study Research, second Edition, Thousand pp. 69-102. Oaks, CA: Sage Publications, 1994. CAPS Research 85 13414_Text 4/11/03 8:29 AM Page 86

CAPS Research

CAPS Research was established in November 1986 as the result of an affiliation agreement between the W.P. Carey School of Business at Arizona State University and the Institute for Supply Management. It is located at the Arizona State University Research Park, 2055 East Centennial Circle, P.O. Box 22160, Tempe, Arizona 85285-2160 (Telephone [480] 752-2277). The Center’s Mission Statement: CAPS Research contributes competitive advantage to organizations by delivering leading-edge research globally to support continuous change and breakthrough performance improvement in strategic sourcing and supply. Research published includes more than 59 focus studies on purchasing/materials management topics ranging from purchasing organizational relationships to CEOs’ expectations of the purchasing function, as well as benchmarking reports on purchasing performance in 30-plus industries. Focus study research under way includes: Major Changes in the CPO and Reporting Line; Purchasing Education and Training in the 21st Century; Return on Investment from E-Supply Chain Solutions; and the benchmarking reports of purchasing performance by industry. CAPS Research, affiliated with two 501 (c) (3) educational organizations, is funded solely by tax-deductible contributions from organizations and individuals who want to make a difference in the state of purchasing and materials management knowledge. Policy guidance is provided by the Board of Trustees consisting of: Stewart Beall, C.P.M., CAPS Research Craig Brown, Intel Corporation Phillip L. Carter, D.B.A., CAPS Research Ken Carty, Coca-Cola USA Edwin S. Coyle, Jr., C.P.M., IBM Corporation Carl Curry, Quaker Foods & Beverages Willie Deese, GlaxoSmithKline Lisa Ellram, Arizona State University Harold E. Fearon, Ph.D., C.P.M., CAPS Research (retired) Edward Hoffman, Eastman Kodak Company Vince Hrenak, Gulfstream Aerospace/General Dynamics Corp. Edith Kelly-Green, Federal Express Daniel Krouse, Hallmark Cards, Inc. Becky Lancaster, Wells Fargo Robert Monczka, Ph.D., C.P.M., CAPS Research/ASU William Nahill, Conoco Phillips Dave Nelson, C.P.M., Delphi Corporation Paul Novak, C.P.M., ISM Larry Penley, Ph.D., Arizona State University Helmut F. Porkert, Ph.D., ChevronTexaco Corporation William L. Ramsey, Honeywell Jim Scotti, Halliburton Company David Sorensen, General Mills, Inc., Vice Chair, CAPS Research A. Keith Strange, United States Postal Service Vic Venettozzi, Schneider Electric North America Stephen Welch, SBC Services, Inc. Joseph Yacura, Six Continents Hotels, Inc.; Chair, CAPS Research 86 The Role of Reverse Auctions in Strategic Sourcing 13414_Cover 4/15/03 12:40 PM Page 2

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